WEEK AHEAD

U.S. Markets Shrug Off Tariff Fears as Jobs Report Fuels Optimism; Manufacturing Red Flag

Last week, the U.S. equity markets demonstrated a surprising resilience, largely shrugging off persistent trade tariff concerns and the Federal Reserve's hawkish stance. A stronger-than-expected Nonfarm Payrolls report emerged as the primary catalyst, fueling a significant push that has many analysts eyeing a potential test of the S&P 500's all-time highs in the coming month.

The S&P 500 gained a notable +1.54% for the week, exhibiting a muted reaction to the Federal Reserve's continued commitment to a restrictive monetary policy, driven by expectations of significant inflationary impacts from ongoing trade tariff negotiations. This equity market enthusiasm stood in stark contrast to the bond market, where yields failed to normalize. Higher yields led to a decline of 43 basis points in the bond market, with 20-year and 30-year yields treading around 5%.

Tech titans continued their ascent to unprecedented valuations, with Microsoft and NVIDIA dethroning Apple to become the most valuable companies. Apple, meanwhile, has experienced a challenging year, declining by over 18% year-to-date. The recovery of the S&P 500 and Nasdaq from their tariff-induced losses captured much of the market's attention. However, quietly outperforming the broader S&P 500 index were Utilities, Financials, and Gold, which locked in year-to-date gains of +10.76%, +6.69%, and a remarkable +25%, respectively. In a notable individual corporate drama, Tesla shares plummeted by -14.9%, as Elon Musk's public fallout with President Donald Trump raised concerns about the company's future government contracts and subsidies.

Economically, the U.S. continues to present a bifurcated picture, with a weakening manufacturing sector juxtaposed against a robust labor market. While there has been a modest decline in payroll gains over the past three months, the overall jobs data has been "better-than-feared," suggesting a strong consumer and a generally healthy economy.

Here's a breakdown of key economic reports from the past week:

• Construction Spending (MoM): Declined by -0.4%, indicating a slowdown in construction activity.
• U.S. ISM Manufacturing Purchasing Managers Index: Declined to 47.5, signaling a contraction in manufacturing activity and a slowdown in new orders.
• Factory Orders (MoM): Dropped by 3.7%, the second worst monthly decline since the COVID-19 pandemic, reflecting uncertainty from trade tariffs and an imminent slowdown in factory activity.
• Nonfarm Payrolls: Rose by 139,000 in May, exceeding the expected +125,000, underscoring the resilience of the job market.
• Unemployment Rate: Held steady at 4.2%, meeting expectations.
• ADP Employment Change: A modest gain of +37,000, falling short of the +99,000 expected.
• JOLTs – Job Openings: Increased to 7.391 million, surpassing both the prior month's reading of 7.192 million and economists' expectations of 7.10 million, indicating continued strong demand for labor.
• Initial Jobless Claims: Increased by 8,000 from the prior week to 247,000, exceeding the 237,000 expected. Continuing Claims, however, saw a slight decrease of 3,000 from last week to 1.904 million.

While the enduring strength of the labor market appears to fuel the current market optimism, manufacturing indicators are flashing warning signs.

This coming week, investors will be poring over fresh economic data, not just for hints, but for stark declarations on the U.S. economy's resilience in the face of escalating trade tensions. All eyes will initially fixate on the Wholesale Inventories and Wholesale Trade Sales report, a crucial barometer for gauging the immediate impact of those much-debated tariffs on the nation's supply chains and corporate stockpiles.

But the true drama unfolds mid-week with the release of the Consumer Price Index (CPI) and Producer Price Index (PPI). These twin inflation reports aren't just numbers; they're the tea leaves from which Wall Street will attempt to divine the Federal Reserve's next move. Will the Fed, in its perpetual dance with economic orthodoxy, finally soften its restrictive monetary stance if inflation figures prove unexpectedly benign? This, of course, would undoubtedly draw the ire of President Trump, who has made no secret of his desire for lower rates. Or, like a stoic Roman senator, will the central bank warrant its current hawkish posture, prioritizing long-term price stability over short-term political expediency? It's a high-stakes poker game, and everyone's holding their breath for the Fed's next tell.

Labor Strength vs. Policy Patience: The Fed's Balancing Act to Serve Two Masters

As we move deeper into Q2 2025, the U.S. labor market continues to defy expectations of a broad economic slowdown. The April jobs report showed the non-farm payrolls rose by 177,000, the unemployment rate remained steady at 4.2%, and average hourly earnings climbed 0.2% to $36.06—firm but not overheating. These figures reflect ongoing demand for labor despite tighter financial conditions, complicating the Federal Reserve's path forward on interest rates.

Despite this strength, the Federal Reserve maintains a cautious stance on interest rate adjustments. April's Consumer Price Index (CPI) indicated a 2.3% annual increase—slightly below expectations but still above the Fed's 2% target. Complicating matters, recent tariffs introduced by the Trump administration have introduced uncertainty around future inflation trends. Federal Reserve Vice Chair Philip Jefferson emphasized that these tariffs could hinder disinflation efforts and temporarily increase consumer prices.

Market expectations reflect this uncertainty. According to the CME FedWatch, there's a 52.4% probability of a 25 basis point rate cut by September. However, the Fed has signaled that it requires more definitive evidence of sustained inflation reduction before making policy changes.

For equity markets, the message is mixed. On the one hand, strong employment supports consumer spending and earnings stability, particularly in cyclical sectors such as industrials and financials. On the other hand, persistent wage gains and a Fed in wait-and-see mode may delay the valuation tailwind typically associated with falling rates. Rate-sensitive sectors such as utilities, real estate, and small caps remain range-bound, awaiting clearer monetary guidance.

Meanwhile, the bond market is flashing signs of caution. The yield curve remains inverted between the 2-year and 10-year notes, but a subtle shift has occurred: short- and long-end yields are rising in tandem, while the middle part of the curve—namely the 5-year—has dipped, forming an unusual "humped" shape. This suggests investor uncertainty around the timing and magnitude of rate cuts, as well as a growing recognition that inflation could prove more persistent than initially hoped.

In this environment, investors face a balancing act. Fading inflation headlines may not be enough to anchor a full risk-on rally unless the Fed aligns more clearly with market expectations. Until then, labor market resilience—while fundamentally positive—may continue to be a double-edged sword, supporting growth but delaying the monetary easing that markets crave. Given the heightened uncertainty and market sensitivity to policy shifts, a cautious stance remains prudent. Close attention to upcoming Fed communications will be essential, as future decisions will hinge on how employment and inflation trends unfold.

Disclosure: The views expressed herein are those of the author and do not necessarily reflect the views of Rayliant Investment Research. The material is for informational purposes only and should not be considered investment advice.  Indices cannot be invested in directly and are unmanaged.  The opinions contained herein are subject to change without notice.