ECB Takes Center Stage; Payrolls on Deck

With the next FOMC policy meeting still eight days away, the European Central Bank has moved into focus with an upcoming meeting on Thursday. 

Amid sluggish growth and encouraging signs of disinflation, the European Central Bank is widely expected to cut rates later this week. In fact, at 99.7%, a first-round 25bp rate reduction in the deposit rate from 4.00% to 3.75% in just two days’ time appears all but certain. 

Of course, even with heightened expectations of an inaugural rate reduction this week, a recent pickup in labor costs suggests the ECB will likely take a tempered approach to subsequent reductions and the future pathway of policy. Down from an earlier forecast of six rate cuts at the start of the year, market participants now anticipate one or two reductions in the remaining six months of the year on a quarterly basis at best. According to members of the governing council, given the still “bumpy” nature of the data, "Policy rates will slowly but gradually move to less restrictive levels.” The exact timing, speed or scale of policy adjustments will follow “a data-dependent approach.”

The European economy has been sluggish for some time, with two consecutive quarters of negative growth at the end of last year. More recently, however, activity levels have improved, rising 0.3% in Q1 with expectations for an average 0.7% pace throughout the year.

Meanwhile, inflation has slowed markedly in the Eurozone from a peak of 10.6% in October 2022 to 2.4% as of April. However, with wage growth steady at 4.5% as of Q4 2023, any unexpected increase would, not necessarily derail the committee’s intentions to move this month, but certainly extend the time between the first and second policy adjustments. 

Back in the U.S., the Fed, meanwhile, continues to reiterate a message of “patience.” Market expectations for rate cuts have dropped from as many as six or seven at the start of 2024 to just about two more recently. Like its counterparts abroad, the Fed continues to maintain a policy bias towards easing – eventually – as this is clearly a Committee desperate to provide relief and continue to perpetuate positive economic conditions. The Fed was arguably tardy to the inflation-taming party in 2022, and now, amid positive growth, elevated price pressures and upside inflationary risks, it will likely delay participating in the policy-easing festivities.

The domestic economy has lost momentum from an outsized annual growth pace of 2.5% in 2023 to just 1.3% at the start of this year, but growth remains solid as the U.S. economy has avoided a technical recession that plagued much of the developed world. Furthermore, with inflation in the U.S. stabilizing well above 2%, and surprising to the upside January through March, Committee members have been crystal clear that it will take “many” more months of improving data before a disinflationary trend can be reestablished to justify a reduction in policy rates. 

Additionally, the Fed – while autonomous from the federal government – would likely seek to avoid a meaningful policy adjustment as the November election approaches. The Fed has in the past increased and lowered rates during an election year both with an incumbent Democrat and an incumbent Republican in office; however, without a clear reason or need to amend policy, the Committee may be more inclined to avoid taking center stage as Americans head to the polls. 

Yesterday on the economic calendar, the S&P Global U.S. Manufacturing Index was revised up from 50.9 to a reading of 51.3, a two-month high.

Also yesterday, construction spending fell 0.2% in April following a 0.2% decline the month prior. Over the past 12 months, construction spending rose 10.0%, the weakest annual gain since September.

Finally yesterday, the ISM Manufacturing Index declined from 49.2 to 45.4 in May, a three-month low. According to the median forecast, the index was expected to rise to a reading of 49.5.

In the details of the report, employment rose 2.5 points to 51.1 in May, the highest reading since August 2022. On the other hand, supplier deliveries remained at 48.9 for the second consecutive month, while prices paid fell by 3.9 points to 57.0, a two-month low and averaging 54.1 over the past six months. Also, inventories declined from 48.2 to 47.9, production slipped 1.1 points to 50.2, new orders decreased from 49.1 to 45.4, and backlog of orders fell from 45.4 to 42.4 in May.

This morning, the number of job openings according to JOLTS – the Job Openings and Labor Turnover Survey – dropped to the lowest in over three years, declining from 8.36M (revised down from 8.49M) to 8.06M to in April. According to the median forecast, there were 8.35M expected job openings. As of April, the job openings rate declined from 5.0% to 4.8% with 1.2 available jobs for each unemployed person, down from a near-term peak of 2 in 2022. Additionally, the quits rate – a measure of people who voluntarily leave their job – remained at 2.2% for the sixth consecutive month.

Tomorrow, weekly mortgage applications data will be released, along with the May ADP employment report followed by the final read on S&P Global U.S. services and composite PMIs, as well as the ISM Services Index for May.

Services activity moved into contractionary territory last month, falling to a reading of 49.4, the first negative print since December 2022. Next week, the ISM Services Index is expected to return to the black, rising to a reading of 50.9 in May.  

Later in the week, on Thursday, weekly jobless claims, nonfarm productivity and unit labor costs for Q1, and the April trade balance will be released, all ahead of the key release of the week – the May nonfarm payrolls report on Friday.  

The focus, however, comes on Friday with a look at the latest employment report. After a smaller-than-expected gain of 175k in April, nonfarm payrolls are expected to rise 185k in May, potentially marking a two-month high with the three-month average potentially falling from 242k to 225k.

The unemployment rate, meanwhile, is expected remain at 3.9% for the second consecutive month, still well below what the Fed designates as the full unemployment range, and perpetuating the notion of tight labor market conditions.

Average hourly earnings are expected to rise 0.3% in May following a 0.2% gain in April, and potentially result in a 3.9% increase over the past 12 months, matching the annual gain in April.  

-Lindsey Piegza, Ph.D., Chief Economist