Without official employment data and amidst lingering concerns over tariffs’ impact on inflation, stocks retreated from record highs as the Fed tempered expectations for an extended easing cycle last week. A continued softening in alternative employment indicators, however, could support the case for another rate cut this year. Provided inflation remains in check, further easing in the absence of a recession, combined with earnings resilience, should continue to support risk assets particularly in rate-sensitive and cyclical sectors, including small caps.
Investors viewed the Fed’s reluctance last week to commit to a December rate cut as more hawkish than expected, given recent labor market softness and its stated focus on employment. This shift in tone weighed particularly on rate-sensitive assets such as small caps, which have retreated from their highs alongside higher short-term rates.
Although the Committee sees tariff-driven price pressures as a one-off, recent research shows roughly 20% of tariffs are passed on to consumers. Persistent concerns about the impact of tariffs on inflation have reinforced the Fed’s cautious stance and limited its willingness to ease more aggressively.
Nonetheless, the Fed remains focused on labor market dynamics, though the absence of official employment data during the government shutdown complicates its assessment. While most alternative indicators do not signal recession risk, the recent uptick in the Challenger layoffs survey underscores that labor market softness may still warrant support. Investors would likely welcome another rate cut this year to bolster employment—provided inflation remains contained.
Despite ongoing uncertainty, small caps have held their ground against the S&P 500, suggesting sentiment remains constructive, even as lingering risks temper confidence. Absent a sharp deterioration in the labor market or consumer spending, steady earnings growth alongside supportive fiscal and monetary policy should remain key drivers for risk assets, particularly cyclicals and rate-sensitive sectors.
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