A Resilient Labor Market Delays Fed Cuts

Last week was very strong for the market narrative because the economic data continued to show resilience where it matters most: jobs, earnings, and investor confidence. The latest payroll report was not just stronger than expected; it showed broad private-sector strength, with government jobs actually declining and the prior month revised higher. That is an important distinction. We are not looking at artificial strength coming from public-sector hiring. We are seeing firms continue to absorb workers in the last two months at a pace well above what many economists now consider steady-state growth.

The unemployment rate held steady, participation slipped slightly, and wage growth came in a little light at 3.6% year-over-year. That wage number is important because it is not running away from the Fed, but it also means workers are barely keeping pace with inflation if headline CPI moves toward the expected 3.7% year-over-year reading next week. This is not the kind of labor report that argues for an immediate rate cut. Jobless claims remain near the very bottom of their long-term range, at 200,000, and we simply are not seeing evidence of layoffs or labor market deterioration. The Fed can take comfort that wage pressure is not accelerating, but it cannot justify aggressive easing with this level of employment strength.

The June 17 Fed meeting will therefore be one of the most important in years, not only because of the policy decision, but because of how Chair Warsh frames the balance between growth, inflation, and the appropriate level of the Fed funds rate. At current levels, with the 10-year Treasury around 4.37% and overnight money in the mid-3s, there is not a strong argument for major easing. I still believe the long bond is likely to settle in a 4.5% to 5% range given the strength of the economy and the persistence of inflation.

But the bond market has shown remarkable strength despite heavy Treasury issuance, and if the 10-Year were to move closer to 4%, because of either weakening consumer spending or non-energy-related prices declining, Warsh would have a stronger argument to lower the funds rate by another 25 basis points. Historically, a spread of roughly 100 basis points between the 10-Year and the funds rate is a reasonable benchmark, and that framework suggests only limited room for easing unless long rates fall further.

Oil remains the major wildcard, but the market has handled the shock impressively. Crude is $8 to $10 lower than last week on hopes for some kind of deal with Iran, even though the geopolitical situation remains fragile. A breakdown could quickly reverse that move. But the key point is that the U.S. economy is far less oil-sensitive than it was in the 1970s. Energy intensity has fallen nearly 70% over the last half century, and oil intensity has fallen even more, close to 90%, because natural gas has displaced oil in critical parts of the economy. Natural gas prices have not moved in the same way as oil, remaining stable, and natural gas remains a major source of electricity generation. That gives the U.S. a cushion that did not exist during the 1973 oil embargo, the 1979 Iranian Revolution, or even the 2008 oil spike.

The most striking development is that the AI trade continues to overwhelm the oil concern. Chip companies are delivering exceptional earnings beats, and more firms are raising guidance than lowering it. That is extraordinary given the geopolitical backdrop and the rise in oil prices earlier in the period. The reason is that AI capital spending is not highly sensitive to gasoline or diesel prices. The market is correctly saying that the productivity potential of AI, the earnings momentum in technology, and the broader strength in corporate guidance matter more than oil staying near elevated levels for several weeks or even months.

Valuations are not cheap, but they are not excessive. At roughly 21 to 22 times forward 12-month earnings for the S&P 500, the market is above average, but once the Magnificent Seven are excluded, valuations fall below 20 times. I have long believed that a 20 multiple is a reasonable long-run anchor for equities in a world of stable inflation and durable productivity growth. There is certainly excitement in chip stocks, and FOMO can always push pockets of the market too far. But with earnings guidance improving, interest rates stable, and investor sentiment moving back toward equities, the trends remain positive.

The next CPI report will matter. Headline CPI is expected to rise 0.6%, down from 0.9% the prior month, while core CPI is expected to tick up to 0.3% from 0.2%. The year-over-year headline number could move to 3.7%, with core around 2.7%. Shelter remains the most important disinflationary force ahead, and both rental and owner-occupied rent measures have stabilized in a way that should feed through to lower inflation readings over the coming months. If oil does not reignite and shelter continues to moderate, inflation can drift lower without the economy needing to weaken materially.