By: Brent Schutte, CFA, Northwestern Mutual
In a week marked by generally stronger economic data—highlighted by Friday’s solid jobs report—the S&P 500 paused, ending a nine-week winning streak with a 2.6 percent decline. While that may seem counterintuitive, it is not unusual at this stage of the cycle. When growth firms but inflation remains elevated, better economic data can raise concerns that the Federal Reserve may need to re-tighten policy—a shift that historically increases the risk of slowing the economy too much.
And while the data were strong, particularly in the labor market, inflation pressures are also showing signs of rising, with energy and food-related inflation continuing to leak into the services sector. The Beige Book, which compiles anecdotal evidence from the 12 regional Fed districts, characterized price increases as moderate to strong while noting that energy-related costs are spilling into areas like shipping, packaging, groceries, and fertilizer. That theme also arose in the May 2026 Institute for Supply Management (ISM) Services Purchasing Managers’ Index (PMI), where prices rose to their highest level since August 2022—another reminder that inflation pressures are broadening, not easing.
The labor market has been the Fed’s primary focus for the past two years. A bout of weakness in late 2024 prompted 100 basis points of rate cuts, followed by an additional 75 basis points in late 2025 as concerns resurfaced. That weakness led the Fed to prioritize supporting growth, even as inflation remained stubbornly above target. Today, however, the picture may be shifting. Core Personal Consumption Expenditures (PCE) inflation sits at 3.3 percent, the same level first reached in November 2023 and is now showing signs of moving higher. With the labor market beginning to heal, investors appear increasingly concerned that the Fed may shift its focus back toward inflation—raising the possibility of rate hikes, which could potentially weigh on future economic growth.
While job growth has reaccelerated, supporting consumption, the underlying income picture is less encouraging. Wage growth has cooled, with average hourly earnings rising 3.4 percent year over year in May—below the 3.8 percent PCE inflation rate in April—and with the May Consumer Price Index (CPI) expected to come in at 4.2 percent. That erosion in real wage growth is meaningful. It suggests that consumer spending is increasingly being supported by savings or equity market gains, both of which tend to be less durable than income-driven demand.
That leaves the economy in a delicate balance. We are seeing the early signs of strengthening after a period of stagnant growth, one that is occurring alongside persistent inflation and a consumer still under pressure. That backdrop will frame new Fed Chair Kevin Warsh’s first meeting on June 16–17, when he inherits not just a complex economy but a divided committee. The last meeting saw four dissents, the highest since late 2022, with three of those tied to removing the easing bias. While the Fed will likely wait as long as it can, especially given the upcoming midterm elections, the direction of travel appears to be shifting. The next move is increasingly viewed as a hike, not a cut—a view that markets are already beginning to price in, with expectations for a 3.88 percent Fed funds rate by December 2026, compared to 3 percent just a few months ago and 3.63 percent today.
Markets, too, are navigating a similarly narrow path. Since the onset of the Middle East conflict on February 22, leadership has been concentrated in technology and artificial intelligence (AI)-related themes. From that data until Thursday June 4, the S&P 500 rose 10.3 percent, driven largely by a 31.4 percent surge in technology stocks. Most concerning has been the rise in speculative areas of the financial markets, with a basket of nonprofitable tech companies rising 54 percent. But Friday’s reversal highlights the fragility of that setup: Large-Cap tech fell 5.8 percent, while nonprofitable tech dropped 7.9 percent, with weakness spilling into other speculative assets like Bitcoin and Ethereum, which fell back toward October 2024 lows. That is not surprising. These are the areas most vulnerable to any future economic slowdown because the promise of what AI may become depends heavily on the capital needed to finance it. These companies need to sustain strong earnings growth, and in many cases, the hopes for earnings remain years away.
In contrast, more defensive areas of the market—utilities, consumer staples, and healthcare—moved higher, as did some economically sensitive sectors like financials and REITs. The S&P 600 index of Small-Cap stocks and S&P 400 index of Mid-Cap stocks also held up relatively well, ending the week higher, likely reflecting already depressed valuations following several years of slower, almost recession-like growth.
So, what comes next? Does the Fed ultimately hike interest rates? Does inflation begin to ease? And how does the AI boom reshape the labor market and the inflation outlook? Over the longer term, we believe the answers to those questions remain constructive. But in the near term, the path is less clear. The Challenger report highlights a rise in AI-related job cuts, suggesting that some displacement is likely in the near term even if more jobs are created because of AI in the intermediate to long term. And while AI is ultimately likely to be disinflationary, it may prove inflationary in the current environment given the bottlenecks it is creating. Factor in the administration’s proposal for a new 10 percent tariff under Section 301, along with the potential for further measures in the weeks ahead, and the result is an environment defined by elevated uncertainty and a wide range of possible outcomes. Stay invested, stay diversified, and stay disciplined.
About the Author:
Brent Schutte, CFA, is chief investment officer of the Northwestern Mutual Wealth Management Company.
