Labor market strength

Bottom line

The lagging impact from stimulative monetary and fiscal policy initiatives over the past two years have combined to help generate a blowout labor market in recent months.

Nonfarm payrolls in May posted a much stronger-than-expected gain of 172,000 jobs, with a combined positive revision of 93,000 jobs during March and April. While the consensus expected a gain of only 88,000 jobs in May, Federated Hermes’ more constructive employment model forecasted a gain of 162,000. May results compare with upwardly revised gains of 179,000 jobs in April (preliminary gain of 115,000) and 214,000 in March (preliminary gain of 185,000).

Private payrolls also added a much stronger-than-expected 120,000 jobs in May (consensus gain of 89,000 jobs expected), compared with upwardly revised gains of 177,000 jobs in April (preliminary gain of 123,000) and 202,000 in March (preliminary gain of 185,000).

As a result, nonfarm payrolls have risen by an average of more than 188,000 jobs in each of the past three months, marking the strongest three-month advance in more than two years. Over the first five months of 2026 (excluding February), nonfarm payrolls have grown at an average of more than 181,000 jobs per month. We intentionally exclude February’s aberrant jobs report from consideration because it was impacted by brutal winter weather that cost 228,000 jobs, health care strikes in California and Hawaii involving another 31,000 workers, and the Labor Department’s downward population revision of 1.4 million household workers. In sharp contrast, growth averaged less than 10,000 jobs a month in 2025.

Fiscal stimulus President Trump signed the One Big Beautiful Bill into law last July. It has sparked a significant increase in corporate capital investment due to its stimulative full-expensing provision. Consequently, the ISM manufacturing index surged to a four-year high of 54.0 in May, and the index has been in expansion territory above 50 for four consecutive months for the first time since 2022. Productivity growth has risen to 2.8% over the past four quarters, compared with an average of 2.0% over the past half century.

How will the Fed respond? The Federal Reserve engineered six interest rate cuts totaling 1.75% over a 15-month period from September 2024 through December 2025. Economic improvement typically lags monetary policy stimulus by 12-18 months, so it makes perfect sense that the labor market did not consistently strengthen until the first half of 2026.

But with the Iran conflict dragging on, crude oil prices (West Texas Intermediate, or WTI) have risen by one-third to $90 per barrel, while gasoline prices at the pump have risen 40% nationally to $4.22 today. Nominal CPI inflation has surged from a five-year low of 2.4% year-over-year (y/y) in February 2026 to a three-year high of 3.8% in April.

Interest rates rising With a strong labor market amid rising energy prices and inflation, investors seem worried the Fed might hike rates by year-end despite new Fed Chair Kevin Warsh’s desire to reduce them.

Benchmark 10-year Treasury yields have risen this week from 4.43% to 4.55% today, while two-year Treasury yields have soared from 4.00% to 4.17%. With the upper band of the fed funds target range at 3.75%, bond investors are now pricing in a quarter-point hike by year end. In contrast, we believe the Fed will patiently ignore the energy supply shock and keep rates unchanged. But it is likely the central bank will neutralize its easing bias in the policy statement released at the Federal Open Market Committee meeting ending June 17.

Stocks hit an air pocket Over the past two-plus months, the S&P 500 surged 21%  to a new record high on Tuesday at 7,621 and the Nasdaq Composite soared nearly 35% to a record high on Wednesday at 30,762. But both have plummeted, by 3% and 6%, respectively, over the past two days, reflecting this labor market strength. We think stocks could correct 10% or so over the summer months given the ongoing conflict in Iran, the Fed’s leadership transition and because it is a midterm election year.

Other key labor-market indicators presaged today’s strength:

• ADP private payrolls Its May report showed that company payrolls rose a stronger-than-expected —and 16-month high — of 122,000 jobs (consensus gain of 120,000 expected) versus a gain of 105,000 jobs in April. Workers who changed jobs last month saw their wages rise 6.5% y/y, less than half the cycle peak of 16.1% in April 2022. Job stayers earned a more modest boost of 4.4% y/y, well below the peak of 7.8% in September 2022
• Initial weekly jobless claims This high-frequency leading employment indicator declined to 210,000 for the survey week that ended May 16. 
• Challenger, Gray & Christmas layoffs Companies announced job cuts of 97,000 in May, 17% higher than April but only 3% higher than year-ago levels. The technology industry accounted for 39% of the layoffs last month, likely due to the growing adoption of AI. 
• Job Openings & Labor Turnover Survey (JOLTS) It strengthened considerably in April, as job openings leapt by 10.6% to 7.62 million, up from 6.89 million in March and 16% higher than December 2025’s five-year low of 6.55 million. However, that is almost 38% below a record 12.182 million job openings in March 2022. New hires at 5.12 million in April rose 4.4% from February’s nearly six-year low of 4.9 million. The rate of job openings soared to 4.6% in April from 4.2% in February and March and well above December 2025’s five-year low of 4.0%. The record was 7.4% in March 2022. The ratio of available job openings for every unemployed worker was unchanged at 1.0 in April, up from a five-year low of 0.9 in February, but still well below a peak of 2.0 in March 2022. The quits rate slipped to a nearly six-year low of 1.9% in April, down from 2.0% in March. 

Unemployment & participation rates steady, labor impairment falls Household employment leapt by 149,000 workers in May, up from declines of 226,000 in April, 64,000 in March, 185,000 in February and 895,000 in January. The unemployment (U-3) held steady at an eight-month low of 4.3% in May for the third consecutive month. April 2023’s 53-year low is 3.4%. The Fed expects U-3 to finish 2026 at 4.4%. The labor impairment rate (U-6) ticked down to 8.1% in May, compared with a seven-month low of 7.9% in February. The cycle low (dating back to 1994) is 6.6% in December 2022. The participation rate was unchanged at a five-year low of 61.8% in May, down from an eight-month high of 62.5% in November 2025.

Wage inflation declines & hours worked flat Average hourly earnings ticked up to a 0.3% month-over-month (m/m) pace in May. But wage growth slowed to a five-year low of only 3.4% y/y in May, down from a 3.7% y/y pace in February. Hours worked were unchanged at 34.3 in May. Each 0.1 change is the equivalent of adding or subtracting an estimated 350,000 workers to or from the economy.

K-shaped labor gap narrows The rate of unemployment for highly educated workers slipped to 2.7% in May from 2.8% in April and March, though up from September 2022’s cycle low of 1.8%. But the unemployment rate for less-educated workers plunged to 6.0% in May from 6.4% in April. That is well above its 31-year low of 4.4% in November 2022. 

Sector details positive:

• Temporary help (an important leading employment indicator) added 1,000 jobs in May, marking its fifth consecutive month of job gains.
• Manufacturing added 7,000 jobs in April, the fifth consecutive month in which jobs did not decline, after eight consecutive months of job losses. 
• Construction leapt to a gain of 17,000 jobs in May, posting job gains in four of the past five months, likely due to the surge in capex spending. 
• Retail lost 1,000 jobs in May, after gains in three of the previous four months. Retail sales were strong in March and April, although we are expecting some seasonal softness in May. 
• Leisure & hospitality hiring surged by a three-year high of 70,000 workers in May, after strong gains of 30,000 in April and 44,000 in March. This recent surge likely accounted for the decline in the unemployment rate for less-skilled workers. 

Read more about our views and positioning at Capital Markets.

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