Introduction

May's employment report proved very strong and included a resounding rise in wages that won't be agreeable to the hawks at the Fed. But outside the labor market, the economy is no better than mixed. Consumers are saving more than they're spending and foreign demand for our products is soft. The Fed's Beige Book, compiled for policy-maker guidance at the June 16-17 FOMC, describes growth as somewhere between moderate and modest with four of the Fed's 12 districts reporting slowing. But the employment report, which is reviving talk of a solid second-quarter rebound, gives this assessment a lift. All in all, the debate at the June FOMC should be lively but probably won't produce the long-awaited rate hike. It was a huge week for economic indicators, so let's get started.

The Economy

Employment up, wages climb

The May employment report proved very strong headlined by a 280,000 rise in non-farm payroll growth which is well above the Econoday consensus for 220,000 and near the top-end forecast of 289,000. Revisions added a net 32,000 to the two prior months. The scary part of the report, that is scary if you're an inflation hawk, is a rise in average hourly earnings which came in at the high end of expectations, up 1 tenth to plus 0.3 percent. Year-on-year earnings are up 2.3 percent, a rate only matched twice during the recovery, the last time back in October 2013. But if we go out two decimal places, the gain is the strongest since October 2009. This reading follows the unusually high 2.6 percent year-on-year rate for the previously released employment cost index. Early signs of wage inflation is where the hawks will be centering their efforts.

Another sign of strength in the May employment report includes the labor participation rate, up 1 tenth to 62.9 percent. The unemployment rate did tick 1 tenth higher to 5.5 percent which no one expected but the gain reflects a jump in those out of work and now looking for work (which is a group included in this calculation). This is a solid sign of labor market improvement and underscores the rock bottom levels in weekly unemployment claims which, across the board, are at 15-year lows.

Looking at industry payrolls, professional business services once again leads the list, up 63,000 following a 66,000 gain in April. Within this industry, the closely watched temporary help services sub-component rose 20,000 after two prior gains of 16,000. The rise in temporary hiring points to permanent hiring in the months ahead. Trade & transportation rose 50,000 followed by retail trade at a solid 31,000. Construction rose 17,000 which follows a 35,000 surge in April. Manufacturing, where exports are hurting, continues to lag, up only 7,000. And mining, which is being clobbered by contraction in the energy sector, fell 17,000 to extend a long run of declines.

Weakness in manufacturing and mining is what the doves will point to as a reminder that not all areas of the economy are on the upswing. And for that matter, not all readings on inflation are on the upswing.

Consumer spending soft, PCE prices also soft

The consumer started off the second quarter slowly, putting income into savings and not spending. The spending side of the personal income & outlays report was unchanged in April with deep declines for both durable and nondurable goods, down 0.7 percent and down 0.5 percent respectively. These declines were offset by another incremental increase in spending on services of plus 0.2 percent.

Personal income, boosted by rents and dividends, rose a solid 0.4 percent though the gain for wages & salaries was less strong at 0.2 percent. The savings rate rose 4 tenths in the month to 5.6 percent which, outside February at 5.7 percent, is the highest in 2-1/2 years. The rise in the savings rate may be a plus if you're a stoic philosopher but not it you're a policy maker trying to get the economy moving.

And the doves get another boost in this report, a key one that contrasts not only with the rise in wages in the May employment report but also contrasts with the recent consumer price report. The PCE price index was unchanged in April and the core up only 0.1 percent. Year-on-year, the core rate fell slightly to 1.2 percent. This is day-and-night compared to the previously released core reading for the CPI which is going in the other direction at 1.8 percent,

But the CPI is not what the Fed looks at first. That honor definitely goes to the PCE price index. There's important differences between the two measures which makes the CPI run on the hot side. Prices in the CPI are based on a fixed basket of items while the PCE allows for substitutions, that is consumers turning to alternative products when the prices of their favored products turn higher. The PCE, compared to the CPI, tends to measure inflation on what consumers are buying most. Also, seasonal adjustments are updated far more frequently for the PCE. The hawks may have the CPI and even average hourly earnings as well, but the doves may still have the advantage with the PCE.

Maybe you can drive my car

The April retail sales report, released mid-month May, proved a big flop, first signaling trouble for second-quarter spending that the personal income & outlays report confirmed. But that was April. In May, consumers weren't holding back when it came to buying cars and trucks which sold at a 17.8 million annual rate, the strongest rate since July 2005 and far exceeding expectations. Month-on-month, the gain came to 7.9 percent which is the strongest since March 2010. Incentives and low rates no doubt boosted sales but May's surge hints at pent-up demand, demand that has built up over the last six months when sales declined four times.

Among details, sales of North American-made vehicles rose 7.6 percent to a 14.2 million rate in a jump that points to a rise for domestic auto production and a rising auto contribution for the factory sector. Foreign-made vehicles sold at a 3.6 million rate for 9.1 percent gain which is among the largest monthly gains on record for this reading. The historic gains in this report point to an outsized surge in May for the motor vehicle component which makes up nearly 1/4 of total retail sales.

Where did my durables go'

Up and down and back and forth. And when  we talk about down and back, the factory sector comes to mind first. The week's big surprise out of the factory sector were sharp downward revisions to durable goods orders, specifically capital goods where initial gains were a major highlight of the prior week's calendar. But no more.

Factory orders fell 0.4 percent in April for the 8th decline in 9 months, a depressing streak interrupted only by March's revised gain of 2.2 percent, a gain inflated by a monthly swing higher for civilian aircraft. The component for durables was revised to a loss of 1.0 percent vs an initial decline of 0.5 percent. But that's not the big news of the factory orders report. Orders for non-defense capital goods excluding aircraft ended up sinking 0.3 percent vs an initial and very strong gain of 1.0 percent. The downward revision to core capital goods orders is a setback, pointing to much less business optimism than first reported and turning lower second-quarter GDP estimates.

Other data in the factory orders report were also weak including no change for total shipments and a 0.1 percent dip for unfilled orders. The lack of punch put pressure on inventory levels where the inventory-to-shipments ratio rose to 1.35 from 1.34 in March.

But there was some badly needed good news for the factory sector in the week. May proved to be a modestly positive month for ISM's manufacturing sample with the headline index rising 1.0 point to 52.8 that was near Econoday's high-end forecast. New orders were the highlight of the report, up 2.3 points to 55.8 for the best reading of the year. Contraction in export orders had been pulling down total orders in many reports but exports in this report were unchanged at break-even 50.0. And there was more good news coming from the week's international trade report where exports for capital goods rose $2.1 billion in April with civilian aircraft representing nearly half the total. Exports of industrial supplies and autos were also higher.

But all in all the factory sector is shaky, reflected where it counts most – in domestic factory jobs. The small rise in manufacturing payrolls for May brings the total rise this year to a pathetic 34,000, a true tail ender.

Construction is not manufacturing

By contrast, the solid rise in construction payrolls in May lifts the year-to-date gain to a more than respectable 112,000. Construction spending was one of the week's big highlights, showing real life with a far higher than expected 2.2 percent gain in April that is in the plus column for second-quarter GDP. Spending on residential construction rose 0.6 percent with strong gains posted for both single-family and multi-family homes. The gain here is no surprise and follows April's big surge in housing starts & permits.

Private non-residential spending looks especially strong in this report, up 3.1 percent and led by gains out of the power and office sectors. Public spending is also strong led by an outsized gain for highways & streets and including a large gain for educational building. The gain in public spending came entirely from the state and local governments as federal construction spending declined for a second straight month. Adding to the positive news were big upward revisions, to plus 0.5 percent from an initial reading of minus 0.6 percent for March and no change from minus 0.6 percent in February. This will help boost the next revision to first-quarter GDP.

Is the service slow'

GDP will, however, continue to rely on the domestic sector for its strength and the latest readings do not point to acceleration. The ISM non-manufacturing index came in near low-end expectations, down a sizable 2.1 points to 55.7 to indicate the lowest rate of monthly growth since April last year. Key readings all slowed slightly but were still constructive with new orders at 57.9 and business activity at 59.5. Employment also slowed, down 1.4 points to 55.3 which is still a respectable rate. Other details included a jump in exports, up 6.5 points to 55.0 in a reading that underscores the rising trade surplus for this services. A look at individual industries shows special strength in management & support services, the latter one of the strongest export industries for the nation.

A second report in the week was Markit's service-sector report where solid rates of growth are also slowing, to 56.2 in May vs expectations for 56.5. Growth in new orders and business activity were both solid, as they were in the ISM report, but, like the headline index, a little slower than previous readings. Backlog orders also rose but at the weakest rate since July.

Markets: bonds are supposed to be safe

You know things are funny when the bond market, week after week, is almost as interesting as the sports page. Incremental moves are supposed to be the rule for this market, not huge gaps. But the Fed's rate hike is moving closer and yields are jumping including the 10-year which positively surged 28 basis points in the week to 2.40 percent. The talk had been that this yield would peak at 2.50 percent when the rate hike finally hits. Well, there may be a risk of overshoot to say the least. Such things, however, aren't bothering European Central Bank President Mario Draghi in the least, telling us "we should get used to periods of higher volatility" which he assures us is common when interest rates are low.

And the risk of overshoot is not being missed by the International Monetary Fund which is concerned that rising U.S. rates tied to the coming Fed rate hike will wobble the globe, sucking money out of the emerging markets and into the U.S. as investors look for yield. And the IMF isn't shy about being dovish, warning the Fed to hold off until next year saying "deferring rate increases would provide valuable insurance against the risk of disinflation, policy reversal, and ending back at zero policy rates."

Volatility wasn't an issue for the stock market in the week which turned slightly lower. The Dow showed little reaction to the jobs report, ending 0.3 percent lower on Friday at 17,849. After holding over 18,000 for most of the last four weeks, the Dow is back where it was in early May. The Dow's loss for the week was 0.9 percent. The Nasdaq posted a 0.2 percent gain on Friday but still ended the week with a fractional loss. The S&P 500 posted a fractional loss on Friday and a 0.7 percent loss for the week.

The Bottom Line

People have jobs, savings are up, and inflation, at least the PCE index, is low. So why mess with that' But the hawks, in their commitment to what's best for the long term, are focused on wages and the risk of inflation. The week's data in full probably do not support a rate hike at the June meeting but are absolutely sealing expectations, at least right now, for a rate hike at the September meeting.

Looking Ahead: Week of June 8 to June 12

Retail sales on Thursday are the week's big event and are expected to show solid lift on a surge in vehicle sales, gains for May that would offset a very disappointing April report and perhaps tilt the second-quarter GDP consensus closer to plus 3.0 percent. Labor market conditions on Monday will also be interesting, whether the gains for the May employment can help give this sagging index a lift. Price data will also be out this week with import & prices on Thursday and producer prices on Friday, with both of these reports having been in deep deflationary ground.

Monday

Last week's very strong employment report should give a lift to the labor market conditions index which has been lagging far behind other employment readings, especially jobless claims and the unemployment rate.

Labor Market Conditions Index - Consensus Forecast for May: 2.3

Range: 2.0 to 2.5 

Tuesday

Until the last few months, the small business optimism index had been lagging behind but then sent out a very strong signal in April. For May, forecasters are looking for a solid increase from April's 96.9 to 97.2.

Small Business Optimism Index - Consensus Forecast for May: 97.2

Range: 96.0 to 97.3

JOLTS data had been very strong until the March report which was very weak. But a big gain is expected for April, one that would underscore last week's very strong employment report for May. Job openings are seen at 5.038 million vs March's 4.994 million.

JOLTS job openings - Consensus Forecast for April: 5.038 million

Range: 5.025 to 5.050 million

Wholesale inventories have been very heavy, the result of weak sales in the sector. Inventories are expected to rise another 0.3 percent in April.

Wholesale Inventories - Consensus Forecast for April: +0.3%

Range: +0.1% to +0.8%

Wednesday

Taxes have been higher this year but Medicare spending is up, keeping the gap in the Treasury budget little changed compared to last year.

Treasury Budget - Consensus Forecast for May: -$97 billion

Range: -$96 to -$97.5 billion

Thursday

Jobless claims have been very low and are expected to stay low in the June 6 week. This report was the first to signal strength in this year's labor market. The Econoday consensus is calling for little change in initial claims, at 275,000.

Jobless Claims - Consensus Forecast for June 6 Week: 275,000

Range: 270,000 to 280,000  

Retail sales have been very disappointing with the report in April sending forecasters back to downgrade their second-quarter GDP estimates. But the May report looks to get a major lift from what was a surge in vehicle sales during the month. Total sales are expected to rise 1.3 percent but with less strength in the ex-auto reading, at plus 0.8 percent. The core ex-auto ex-gas reading, coming off a small gain in April, is seen climbing a respectable 0.5 percent.

Retail Sales - Consensus Forecast for May: +1.3%

Range: +0.5% to +1.8%

Retail Sales Ex-Autos - Consensus Forecast for May: +0.8%

Range: +0.5% to +1.3%

Retail Sales Ex-Autos Ex-Gas - Consensus Forecast for May: +0.5%

Range: +0.2% to +0.6%

There have been some hints that price pressures may be building but not many in import & export prices where most readings have been in outright contraction for a full year. The strong dollar is making imports cheaper while softness in foreign economies is keeping down prices on the export side. But energy prices are rebounding and gains, including a strong gain for import prices, are expected for May.

Import Prices - Consensus Forecast for May: +0.9%

Range: +0.0% to +2.3%

Export Prices - Consensus Forecast for May: +0.1%

Range: -0.2% to +0.2%

Business inventories were rising relative to sales earlier in the year in what perhaps reflected the special problems of the first quarter (weather, port strike, energy sector weakness). Inventories are expected to rise 0.2 percent and if sales can exceed this rise, the combination would help ease overhang.

Business Inventories - Consensus Forecast for April: +0.2%

Range: +0.1% to +0.5%

Friday

Gains for energy prices are expected to give the producer price index – final demand a lift out of the negative column. But when excluding energy, readings in this report are not expected to show any life.

PPI-FD - Consensus Forecast for May: +0.4%

Range: +0.2% to +0.6% 

PPI-FD Less Food and Energy - Consensus Forecast for May: +0.1%

Range: 0.0% to +0.3% 

Consumer sentiment remains in solid ground and is expected to rise slightly for the flash June reading, from 90.7 in May to 91.2. The current conditions component of this report offers the first look at how June is unfolding.

Consumer Sentiment - Consensus Forecast for April: 91.2

Range: 89.0 to 93.0