US Equities Rally as Resilient Labor Market Fends Off Interest Rate Cut Prospects

US Equities Rally as Resilient Labor Market Fends Off Interest Rate Cut Prospects

A solid labor market is the biggest hold-up to the US Federal Reserve’s push to cut interest rates in June. A robust March jobs report is pushing the US central bank into a more cautious approach with regard to potential rate cuts. On Friday, the Labor Department’s nonfarm payrolls showed that the US economy added 303,000 jobs, which is much better than the initial target of 200,000.

Resilient US Economy

An intense job outlook raises the prospect of more significant inflationary pressures that the Fed fears. With more people working, consumer spending power should remain strong, which could push prices higher, derailing the Fed’s push to get inflation back to lows of 2%. Consequently, as initially thought, the market is pricing less than a 50% chance that the Fed will start cutting interest rates in June.

The prospect of the Fed staying put and not cutting interest rates at 22-year highs of 5.25% and 5.50% has done little to dent sentiments in the stock markets. Investors have continued to bet on US stocks, pushing the major indices up, led by the S&P 500, which was up by about 10% in the first quarter.

After a minor correction as the first quarter came to a close, US stocks bounced back in the aftermath of the solid jobs report that affirmed the resilience of the US economy amid the high-interest rate environment. Much of the job gains have come from the healthcare, leisure, hospitality, and government sectors. The construction sector has also contributed a significant chunk of the gains.

Economists Warnings

According to Seema Shah, chief global strategist at Principal Asset Management, the Fed’s failure to cut interest rates at its June meeting would result from a strong US economy that should continue to offer support to the equity markets. Nevertheless, there is growing concern in various quarters that the Fed will pay a hefty price for being restrictive for too long.

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According to Allianz economic advisor Mohamed El Erian, the Fed has become too reliant on rolling data points and should focus on its longer-term strategy instead. This highlights the potential risks of the Fed’s cutting interest rates.

Some economists have already started to raise the alarm bells that swelling immigration numbers could have a say in keeping job numbers high. Siting numbers from the Congressional Budget Office, Goldman Sachs estimates that 2.5 million immigrants crossed the US borders in 2023, the highest level in over two decades.

Energy Crisis on Inflation

In addition to a solid labor market, an energy crisis continues to thwart the push of the Fed to cut interest rates. A supply crunch fuelled by soaring geopolitical tensions and shipping disruptions continues to send oil prices higher, making it difficult for inflationary pressures to drop below the recommended 2% in the US.

The Energy Select Sector SPDR Fund (XLE) was up by 12% in the first quarter of the year, outperforming the S&P 500, which was up by about 10%. The gain comes on oil prices finding support above the $75 a barrel level in recent months amid strong demand amid heightened supply cuts.

The new quarter has been greeted with escalating tensions in the Middle East, with Iran threatening to invade Israel, all but fuelling geopolitical tensions. A direct Iranian involvement in the Israel-Hamas war could spark a region-wide conflict that could impact oil supply, therefore sending prices higher.

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