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Job growth shifts to slower gear along with economy

Employment growth in April fell to a seven-month low, signaling that the economy's job engine may be shifting into a lower gear.

The economy added just 160,000 jobs in April, while the unemployment rate remained at 5 percent. That is well below the 202,000 jobs expected by economists and the 12-month average payroll growth of 232,000. Bright spots were a slightly better-than-expected wage gain of 2.5 percent year over year, and a 0.4 percent increase in private sector hours worked.

"It really puts off the Fed," said John Briggs, head of rate strategy at RBS. "We've had a number that misses then the trend comes back. I'm not ready to say Q1 weakness has totally filtered through to Q2, but it's a concern."

Read MoreEconomy whiffs on jobs creation

Both Barclays and Bank of America Merrill Lynch said that the report eliminates any chance of a June Fed hike, and that it now expects just one rate increase this year — in September. Goldman Sachs, which had expected 240,000 jobs, also dropped June from its rate forecast, and pointed to September for the next hike.

Stock futures initially fell but turned higher in early trading. Bond yields dropped and the dollar weakened but both moved off lows. Futures markets, however, showed lower expectations for a Fed rate hike, with the first full rate rise now not priced in until October 2017, according to RBS. The odds of a June hike fell into single digits while December odds were roughly 50 percent.

"What it does signal is a kind of view we had coming into 2016 that we're expecting more slowing but moderate growth," said Ron Sanchez, chief Investment officer at Fiduciary Trust Company International. "If you look at the way 2016 appears to be unfolding — we're slower and lower for longer. That's a commentary on growth, interest rates and monetary policy."

Latest forecasts put first-quarter growth tracking at 0.7 percent, according to CNBC/Moody's Analytics Rapid Update. Most economists expect the second quarter to have picked up to about 2 percent.

Read MoreThe market saw this weak jobs report coming; Goldman did not

The slowdown in job growth has been expected, not only because of the slow-growing economy but because the higher pace is unsustainable after the economy has added so many positions. Goldman Sachs economists, for instance, had predicted full employment by year-end.

"The U.S. economy is in good shape on a global basis. I don't think we're going into recession this year, but it's definitely declining," said Rick Rieder, BlackRock's chief investment officer of global fixed income. Rieder agreed that the reason for lower job growth is twofold.

"We've taken out so many qualified applicants but then it's happening contiguous to the fact that companies are cutting back on capex, cutting back on inventory and cutting back on hiring," he said.

Rieder sees a 35 percent chance that the Fed will not move at all on a rate hike this year, and a 30 percent chance that it cuts just once. The Fed's forecast has been for two rate hikes, and central bank officials have said they will consider an increase at every meeting, basing their decision on the economic data and financial conditions.

John Canally, economist and strategist at LPL Financial, said the Fed would still consider 150,000 jobs as enough to tighten, while the markets would not. He too expects a slower rate of hiring.

"It's probably going to downshift into the 150,000 area. It just has to. We're later in the business cycle. Just from the math alone, we've added a lot of jobs," he said.

Adding to the disappointment around the jobs report was a downward revision in February and March jobs of 19,000 workers, and a slight decline in the participation rate to 62.8 percent. Government jobs also dropped by a surprising 11,000.

Diane Swonk, CEO of DS Economics, said the hit from government declines in April was big, since it was expected to be positive. "It was a swing month to month of 25,000. Government was the Achilles' heal," she said. Barclays said the government losses were postal workers and local government education services.

But overall Swonk said the report had some silver linings.

"There are fewer but better-quality jobs. They're dominated by business and professionals. It's new college grads. It's part of the reason why year over year, we had an acceleration in wages. They are full time, science, engineering and accounting," she said.

The professional and business sector added 65,000 jobs in April. Health care rose by 44,000 and financial activities rose by 20,000. Mining employment continued to decline, falling by 7,000.