The increase of 172,000 jobs in the May U.S. employment report released on Friday is the opening of an economic symphony in two movements that will conclude with the release of the consumer price index on June 10.
We expect inflation in that report to show an increase of 4.2% from a year ago, setting the stage for a challenging second half of the year.
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Strong upward revisions to the March and April data show a three-month average increase in employment of 188,000 jobs a month.
The increase in leisure and hospitality hiring as well as stronger government employment is not sustainable and overstates the true underlying pace of hiring, which we think is closer to 150,000 per month.
Friday’s strong jobs report, which had a 4.3% unemployment rate and modest nominal wage growth, provided a fast-paced opening movement to that symphony that will be followed by a far more complex inflation report.
The CPI report will include new data on the energy, transportation, fertilizer and food price shocks that have caused a decline in real wages.
Such is the reality of our dissonant economy.
State of play in the labor market
Following a year of uneven job growth that has slowed notably, we think that the labor market has stabilized and is on the cusp of a mild acceleration.
A robust increase in nonresidential investment, fueled by the construction of artificial intelligence infrastructure, along with booming corporate profits will support a faster pace of hiring in the second half of the year.
This means that the recent hand-wringing over the employment status of new college graduates will ease notably as firms seek the exact type of skilled workers—those that know more about technology than they can adequately communicate—to capitalize on investment that seeks to bolster productivity.
In an economy where the breakeven rate to keep labor conditions stable is only 25,000 new jobs per month, the three-month average monthly increase of 188,000 amid the 4.3% unemployment can fairly be identified as in balance.
While one can take comfort in such an unemployment rate and a gain of 0.3% in average hourly earnings, which translates to a 3.4% nominal increase in wages from a year ago, the supply shock washing over the American economy demands that wage data be inflation adjusted.
If the May CPI arrives in line with our forecast of a 0.5% monthly advance and a 4.2% annual increase, it would imply that once one adjusts wages for inflation, earnings will have declined for the second straight month and will have fallen by 0.8% from a year ago.
Despite the stabilization in hiring and a coming acceleration in total employment, we doubt that the American public will find solace in such data now that inflation is outpacing wage growth.
Policy implications
Should our inflation forecast be correct, or slightly off target, it will lessen the impact of an otherwise uplifting opening labor market movement.
The May jobs report should assuage concerns among policymakers that a labor market that experienced a net job loss of 42,000 positions between June 2025 and February 2026 has now stabilized.
Under normal circumstances, such a stabilization amid modest nominal wage growth would imply a Federal Reserve discussing the logic of rate cuts to get the policy rate toward its definition of neutral.
But these are not normal times.
Given the uncertainty over the Iran war, as well a complex inflation picture, it is difficult to paint a picture of a steady progression to prosperity for the average worker.
Should top-line inflation end up bleeding into core pricing and continue its five-year run above the Fed’s 2% target, both professional investors and the public will reset their inflation expectations higher. The Fed as a result will be forced to lift rates as early as this summer.
When the Fed announces its policy decision on June 17, we expect the central bank to remove the easing bias from its policy statement and put forward a hawkish hold to kick off Kevin Warsh’s tenure as Fed chair despite a solid three months of hiring and mild nominal wage growth.
The data
The primary driver of the jobs gains in May was an increase of 120,000 in private sector hiring led by 70,000 new jobs in leisure and hospitality, 40,000 in private education and health care, and 52,000 in government.
Away from those sectors, hiring was restrained. Higher-paying goods-producing jobs increased by 28,000, construction added 17,000 and manufacturing 7,000. Professional business services increased by 6,000, and there were 1,000 new temp jobs created.
The trade and transport sectors declined by 3,000 jobs, retail trade by 1,000, information by 2,000 and the financial sector by 22,000 on the month.
Total private hours worked remained unchanged on the month as average hourly earnings advanced by 0.3% and rose by 3.4% from a year ago. The three-month average annualized pace of wage gains stands at 3.1%, which should garner the attention of policymakers given the expectation that CPI will increase to 4.2% in May.
We think that inflation will increase to 4.5% in the near term, which does not bode well for consumption in the second half of the year.
The takeaway
One sign of a fine textured mind is the ability to hold two simultaneously contrasting ideas and arrive at synthesis.
This is the nature of our K-shaped economy, where those with higher incomes are thriving while those with lower incomes are struggling, that must be addressed as it is and not how we wish it to be.
Whether it be a technological framework driven by artificial intelligence that is at once economically transformational yet socially disruptive, or an economy generating increasing employment that results in falling real wages, this is the American rite of spring that we are facing.
Hiring has stabilized and we think it is on the cusp of acceleration because of improved capital expenditures driven by the buildout of AI infrastructure and rising corporate profits.
Yet, despite these trends, they are not sufficient to offset an equally historic supply shock that is resulting in inflation outpacing wage growth.
The second half of 2026 is going to be anything but boring.
