Super strong jobs report means June rate hike coming and Fed could get more aggressive

An employee inspects the quality of a finished suit jacket at the Joseph Abboud Manufacturing facility in New Bedford, Massachusetts.
Scott Eisen | Bloomberg | Getty Images
An employee inspects the quality of a finished suit jacket at the Joseph Abboud Manufacturing facility in New Bedford, Massachusetts.
  • Hiring in May was strong and the monthly employment report showed solid jobs gains of 223,000, a lower unemployment rate of 3.8 percent and a better-than-expected boost in wages.
  • The strong jobs report keeps the Fed on track to raise interest rates by a quarter point later this month and possibly even increase its forecast for rate hikes for this year.
  • Stock futures moved higher and bond yields jumped as the market again is moving to price in a fourth Fed rate hike for this year.
  • Economists had only expected 188,000 nonfarm payrolls and an unemployment rate of 3.9 percent, according to Thomson Reuters.

May's super strong employment report, including a slightly better gain in wages, signals the Fed is on track to raise interest rates in June and could even add another rate hike to its forecast this year.

Employers created 223,000 new jobs in May, well above the 188,000 expected, and the unemployment rate fell to 3.8 percent, after reaching a low 3.9 percent in April. Wages grew by 0.3 percent, or 2.7 percent year over year, better than the 0.2 percent expected.

"There's a lot to like in this. Quite frankly, it's hard to find any holes at all. For the most part, this is just great. Payroll growth reaccelerated. The decline in the unemployment rate was not only supported but beaten. Hourly earnings are good," said Ward McCarthy, chief financial economist at Jefferies. "The Fed was going to go ahead anyway, but it certainly reduces the arguments of those that don't want to go."

The number of unemployed fell to 6.1 million, a figure that has dropped by a half percentage point or 772,000 this year. Hiring trended up in a number of industries including retail trade, health care and construction.

Markets had focused on the wage element of the jobs report, waiting to see a tick-up in wages that would signal more inflation ahead. A higher inflation rate would confirm the Federal Reserve's forecast for three rate hikes this year and even encourage it to hike a fourth time, as many in the markets suspect it might.

Stocks rose on the report, and bond yields, which move opposite price, went higher. The 10-year yield was at 2.91 percent, and the 2-year was at 2.47 percent.

"The Fed has been focused on wage inflation forever. The thing that could affect the Fed is a bad print related to wages. This is a pretty good print," said Michael Schumacher, director of rate strategy at Wells Fargo. "The economy looks solid and I'd say has been looking good for a long time. The missing link has been wages and as wages pick up, it makes the Fed look at it and say this is what we want."

Chris Rupkey, chief financial economist at MUFG Union Bank, points out wages rose even more for nonmanagement workers — up 2.8 percent year over year.

"Net, net, the economy accelerated in the second quarter with businesses hiring more workers that will pump new life into the outlook and keep this expansion on track to smash the ten year record of growth during the roaring 90s," he wrote in a note. "The Fed meets in less than two weeks, and another rate hike along their gradual path of firming interest rates is a slam dunk."

Retail added a surprising 31,000 jobs, a category that has been weak as shoppers move online. There were also additions of 29,000 in construction and 29,000 in health care.

Schumacher said expectations for a fourth rate hike this year, as reflected in fed funds futures, rose slightly after the jobs number. The Fed is expected to announce its second rate hike this year, after its meeting on June 13.

Earlier this week, as the markets focused on political chaos in Italy, some traders began to bet against the view that the Fed could raise rates a fourth time, and some even doubted a third hike this year.

"I think this really just keeps the process going of getting rid of the Italy discount," said Schumacher of the market moves after the jobs report. After Tuesday's tumult, markets were soothed by the fact that Italy was moving forward to form a government.