On the surface, last Friday’s jobs report looked picture-perfect.
Nonfarm payrolls data showed the economy added 172,000 jobs in May on top of April’s upwardly revised 179,000 figure. It comfortably beat expectations of 85,000.
The labor market remains incredibly resilient. Unemployment is holding steady at 4.3%, while last week’s Job Openings and Labor Turnover Survey showed job openings surged by 731,000 to 7.62 million – the biggest increase since November 2024.
Add in recent data showing that both the manufacturing and services sectors continue to expand, and you’d be forgiven for thinking the economic outlook seems bright.
But investors didn’t rejoice at this good news. Last Friday, the stock market experienced a dramatic sell-off…
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Here’s the thing about the stock market. What seems like good news on the economic front can spell trouble for stocks.
For much of this year, the stock market has assumed that inflation would gradually ease. That would give the Federal Reserve room to cut interest rates.
Lower interest rates are generally a good thing for the stock market, as it makes it easier for companies to borrow money and expand their businesses. (It also makes alternatives like parking your money in T-bills less attractive.)
Expectations for slowing inflation remained intact despite oil prices surging through the $100 level when conflict broke out in the Middle East. Folks thought that the hostilities would be short-lived.
Plus, Kevin Warsh just became the new Fed chair. As Trump’s pick, many believed he would push for lower rates. (Note that his first FOMC meeting as chair is just eight days away.)
In response, investors jumped back into the AI trade, pushing indexes to a succession of new highs.
But a stronger-than-expected economy complicates the picture around rates…
When businesses are hiring and economic activity is strong, it’s hard for the Fed to consider cutting rates. Plus, there’s no evidence yet that inflation is under control. What’s more, inflation could easily accelerate if hostilities in the Middle East escalate, as we saw over the weekend.
That’s what suddenly caught the market’s attention last Friday. Rates aren’t going down anytime soon. Instead, they could move higher…
Following Friday’s data, U.S. Treasury yields moved sharply higher as traders reassessed the outlook around rates. Investors are now factoring in a 46.7% chance of a 0.25% rate hike by the end of the year, with a 22.1% chance of a 0.5% increase.
If oil surges again, putting more pressure on inflation, those odds could increase further.
Clearly, the market’s narrative around interest rates is changing. That’s important, despite all the hype around AI, SpaceX, and other potential IPOs.
Higher rates increase borrowing costs and pressure business margins. They also make lofty stock valuations harder to justify, which is especially true for the AI stocks that have driven much of the rally.
No doubt Friday’s sell-off was painful for a lot of folks. But it was also a timely reminder that markets can’t live on hype alone. At some point, things must come back to fundamentals.
So if oil, inflation, and yields all stay higher than investors anticipated, there will be a reckoning. Stocks can’t keep moving higher when the underlying fundamentals change.
Sometimes good news isn’t good news at all. As we saw on Friday, sometimes it forces the market to confront a reality that it had been trying to ignore.
Regards,
Larry Benedict
Editor, Trading With Larry Benedict
Reading Trading With Larry Benedict will allow you to take a look into the mind of one of the market’s greatest traders. You’ll be able to recognize and take advantage of trends in the market in no time.
