We have repeatedly highlighted the delicate balance that the U.S. economy and markets remain suspended in as the Federal Reserve treads a thin line between a softening labor market and stubborn inflation that continues to hover above its 2 percent target. More recently, uncertainty surrounding tariff policy and the military conflict in Iran have added to the myriad of risks the central bank must weigh as it attempts to navigate the transition from a period of high inflation and aggressive interest rate hikes to a more stable environment.
Historically, labor market weakness and elevated prices have rarely occurred simultaneously because they are driven by opposing forces of aggregate demand. This economic cycle has proved anything but typical, however. As we find ourselves in a historically odd tension point between sticky inflation and a labor market that has proved much narrower and softer than the original data showed—which appears to be getting only weaker—the question remains as to where interest rates and monetary policy will move as a result.
The good news is that interest rates have pushed lower over the past year, which could help broaden economic growth if they remain at current levels or continue to drop. This isn’t a given, however, due to two pressing realities:
First, the reason rates have moved lower is primarily a weakening and deteriorating labor market, as job growth has pulled back toward zero and more noncyclical sectors (such as education and health care services, which represent around 17 percent of total labor employment) do the majority of the heavy lifting. This very labor market weakness has been a primary force in motivating the Fed to drive interest rates lower because it signals the potential for slowing economic momentum. However, should employment weaken even further, it could trigger a possible economic contraction, which has (at least historically) been a symptom of unchecked labor weakness.
Second, inflation has remained stuck around 3 percent for the past two years—not 2 percent, as the Fed has continually strived toward—leaving it an ever-present risk. Almost all data continues to suggest that inflation embers have yet to be extinguished, most recently evidenced by the Institute for Supply Management (ISM) Manufacturing Prices Index, which skyrocketed to 70.5 percent in February 2026, up from 59 percent in January—the highest level since June 2022 in a spike largely attributed to increased steel and aluminum prices and the impact of new tariffs on imported goods. Geopolitical instability following the U.S. and Israeli-led attacks on Iran has caused a spike in energy costs, which is adding to lingering inflation risks. If inflation continues to show signs of pushing higher, it could lead to a pause in the rate-cutting cycle while placing additional pressure on more interest rate-sensitive parts of the U.S. economy.
This underscores the delicate balance of the economy and markets over the past few years as the higher interest-rate environment has favored more-affluent consumers who have benefitted from a rising stock market driven by a narrow group of artificial intelligence (AI)-leveraging stocks. As interest rates have begun to come down, we have seen incremental signs of a broadening economy and market, both of which would serve to increase the stability of the delicate balance. These tensions were on display this week as the growing Middle East conflict heightened inflation pressures, with the closure of the Strait of Hormuz, a critical global oil chokepoint accounting for 20 percent of the world’s daily oil consumption, triggering a spike in global energy prices. This has forced production shutdowns, supply bottlenecks and steep inflationary pressures on energy-dependent economies across Europe and Asia. These heightened inflation tensions clashed with growing labor market and economic concerns on Friday as nonfarm payrolls posted a largely negative print and January retail sales disappointed for the second month in a row.
These negative insights contrasted with more positive economic data, including the more forward-looking aspects of the ISM Services and Manufacturing PMIs and the prospect of larger tax rebates for consumers in the first quarter given the stimulative aspects of the One Big Beautiful Bill Act, which could offset recent retail sales weakness. How all of this plays out remains a very delicate question.
This potential for a “stagflationary” economic environment caused Treasury yields to experience their largest weekly jump since April 2025. The 10-year increased by nearly 20 basis points over the week, finishing at 4.14 percent on Friday, while the two-year rose to 3.56 percent. The S&P 500 index fell 2 percent, while recent progress in terms of market broadening also took a hit, as Small- and Mid-Cap stocks ended the week down 3.8 percent and 4.6 percent, respectively; international stocks ended the week with their worst performance in nearly a year given their dependence on oil and natural gas that passes through the Strait of Hormuz. The MSCI International Developed Markets fell 6.7 percent, while the MSCI Emerging Markets shed 6.8 percent. The biggest positive was an 8 percent move higher in the Bloomberg Commodities index, an asset class that we believe possesses positive diversification aspects for investors. The current environment is marked by heightened volatility that will likely remain for some time. But by adhering to a diversified asset allocation driven by a financial plan based on your financial goals and objectives, even major bouts of shorter-term volatility can be navigated with confidence.
Wall Street wrap
Soft employment figures carry over from 2025 despite economic growth: The latest U.S. Bureau of Labor Statistics Employment Situation report for February showed continued labor softness, with total nonfarm payrolls falling by 92,000 after a gain of downwardly revised 126,000 jobs in January. This follows a weak 2025, when job gains averaged only 15,000 per month after major downward revisions. Private Sector Payrolls reported a loss of 86,000 jobs in February, echoing the weakness seen in 2025, when the private sector averaged roughly 30,000 jobs per month.
The unemployment rate edged up slightly to 4.4 percent, while average hourly earnings rose 0.4 percent month over month to $37.32, leaving wages up 3.8 percent year over year. Revisions also lowered earlier data: December payrolls were revised down from +48,000 to –17,000, and January was revised slightly to +126,000, indicating weaker job growth overall than previously reported.
The report’s diffusion index, which measures how widespread employment gains are across industries, also suggested limited breadth in hiring. The one-month diffusion index total for private industries was about 50.8, only slightly above the neutral 50 level, indicating that roughly as many industries were adding jobs as losing them. The previous stalwarts, education and health services, which have been responsible for all employment gains in 2025, reported a loss of 34,000 jobs—largely due to a temporary strike at Kaiser Permanente that took approximately 31,000 workers off payrolls during the survey period.
Given the swings in employment data, we believe that it is best viewed over multiple months, especially after last month’s surprisingly strong jobs data gave way to this surprisingly weaker report. Total nonfarm payroll has averaged 6,000 over the past three months, with the six- and nine-month averages residing at –1,000 and –4,000. Private payroll growth paints a slightly better picture, with the monthly average at 18,000 the three-month at 34,000 and the nine-month at 23,000. Overall, no matter how you slice and dice it, the labor market remains narrow and weak.
Private-sector data reinforces cooling labor demand: Private-sector labor market indicators released this week from ADP; Challenger, Gray & Christmas; and Revelio Labs painted a mixed but generally cooling picture of U.S. employment conditions ahead of the official government jobs report.
ADP’s National Employment Report showed that private payrolls increased by 63,000 jobs in February, a notable improvement from a downwardly revised 11,000 in January and slightly above economists’ expectations of around 50,000. Hiring was concentrated in a few sectors, especially education and health services (+58,000) and construction (+19,000), while professional and business services lost about 30,000 jobs and manufacturing fell by 5,000. Pay growth also remained solid, with annual wages rising about 4.5 percent, although the pay premium for switching jobs dropped to a record low, indicating limited bargaining power for workers.
The Challenger layoff report showed that announced job cuts fell sharply to 48,307 in February, down 55 percent from January’s 108,435 layoffs and 72 percent lower than February 2025. Despite the monthly decline, layoffs earlier in the year were elevated, and the technology sector led cuts with about 11,039 job reductions, followed by education and manufacturing. The firm noted that uncertainty around economic conditions and geopolitical risks could lead companies to announce more layoffs later in the year.
Finally, data from Revelio Labs, which tracks labor market activity using real-time employment and professional profile data, indicated that the U.S. economy shed roughly 17,000 jobs in February in its dataset. The decline was driven mainly by retail trade and leisure and hospitality, while health care, professional services, and financial activities posted gains. The report also showed signs of cooling labor demand, with active job postings and wages for new job listings falling slightly.
U.S. manufacturing expanded in February, but soaring input prices stoked inflation fears: The ISM Manufacturing PMI came in at 52.4, slightly down from 52.6 in January, showing that factory activity continued expanding for the second consecutive month albeit at a slightly slower pace. At the same time, input prices soared at the fastest pace since 2022, fueling worries of an inflation resurgence even before this past week’s conflict in Iran.
The prices paid index jumped sharply to 70.5 from 59, its highest level since 2022, signaling rising input costs and increasing inflation pressure in the supply chain amid higher import levies imposed by the Trump administration and underscoring the current delicate economic balance.
On the brighter side, the backlog of orders index rose to 56.6 from January’s reading of 51.6, the first two times this category has been in expansion since September 2022 and the highest figures registered since May 2022. Other key components such as new orders (55.8 vs. 57.1 in January) and production (53.5 vs. 55.9) cooled somewhat, while the employment index remained in contraction at 48.8, suggesting manufacturers are still cautious about hiring. The inventories index rose 1.2 percentage points to 48.8 percent from January’s 47.6 percent but still remains in contraction—indicating that the rate of inventory reduction has slowed.
Services continue to expand amid strengthening demand: By contrast, the ISM Services PMI rose strongly to 56.1 in February, up from 53.8 in January—the fastest expansion in the services sector since mid-2022. Business activity increased to 59.9 from 57.4, and more industries reported growth, reflecting stronger demand in sectors such as retail, finance and health services. While services prices eased slightly (63.0 vs. 66.6 in January), they remained above 60 for the 15th consecutive month. However, February’s reading marks the lowest since March 2025 (61.4), suggesting that cost pressures are still present even as demand strengthens.
Taken together, the ISM data suggest the broader U.S. economy is still expanding, with particularly strong momentum in the services sector, which makes up the majority of economic activity.
Retail sales lose momentum post-holidays: Retail sales fell 0.2 percent in January 2026, according to the latest U.S. retail sales report from the Census Bureau, the first decline in three months. The drop followed flat retail sales in December, indicating that consumer spending lost momentum after the holiday season.
The weakness was driven mainly by declines in motor vehicle and gas station sales, partly reflecting lower gasoline prices and softer demand for big-ticket items. Several retail categories—including clothing, electronics, and restaurants—also posted declines, while online retail sales rose about 1.9 percent and some housing-related categories like building materials saw gains.
However, underlying demand appeared somewhat stronger when volatile components were removed. Core retail sales (excluding autos, gasoline, and building materials) increased about 0.3 percent, and the control group used to calculate GDP also rose around 0.3 percent, suggesting that the underlying consumer spending trend remains positive even though the headline number declined
The week ahead
Tuesday: The National Federation of Independent Businesses is scheduled to release its monthly Small Business Economic Trends report at 9:00 a.m. EST.
Additionally, the National Association of Realtors will release the Existing Home Sales report for February 2026 at 10:00 a.m. EST. This report is a critical indicator of the U.S. housing market’s health, covering transactions for existing single-family homes, condos and co-ops. Following a 5.9 percent decline in March 2025 and a challenging start to 2026, experts are looking for any sign of a market turnaround.
Wednesday: The Consumer Price Index (CPI) data for February 2026 is scheduled for release by the Bureau of Labor at 8:30 a.m. EST. This report is critical because it arrives less than a week before the Federal Reserve’s next policy meeting, with economists widely expecting the headline CPI to rise by 0.3 percent from January to February.
Friday: The Personal Consumption Expenditures report is scheduled for release by the Bureau of Economic Analysis (BEA). This report highlights the Federal Reserve’s preferred inflation gauge, covering consumer spending and price changes for January 2026. Should the report show core inflation is still well above the Fed’s 2 percent target, it could motivate the central bank to raise interest rates.
Separately, the University of Michigan is scheduled to release at 10:00 am EST its preliminary March 2026 Survey of Consumers, a closely watched indicator of the U.S. economic outlook, highlighting how confident households feel about their finances and the general economy. Overall sentiment is expected to remain nearly unchanged at a relatively low level of 56.2 from the initial March report, but recent geopolitical turmoil in the Middle East and tariff policy uncertainty could impact that outlook.
Finally on Friday, the BEA will release at 8:30 a.m. EDT the Second Estimate of Fourth Quarter 2025 GDP and the Annual 2025 GDP reports at 8:30 a.m. EDT, critical updates to the advance estimates released in February that will feature more comprehensive data.
Brent Schutte, Chief Investment Officer
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