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.
Read more: AI Drives Stock Market Higher Despite Uneven Growth
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.
Wall Street wrap
Inflation ripple effects broaden as energy shock spreads through supply chains
Last week, the Federal Reserve Bank of Kansas City compiled and released the May 2026 Beige Book, two weeks ahead of the Federal Open Market Committee’s next scheduled monetary policy meeting on June 16–17. The latest iteration underscores a key shift in the inflation story: While higher energy prices remain the initial catalyst, the more important development is how those pressures are now spreading across the broader economy. Across most Fed districts, prices increased at a moderate to strong pace, with inflation accelerating relative to the prior report. What stands out is that energy-driven cost increases are spilling over into areas like shipping, packaging, groceries, and fertilizer, effectively moving deeper into supply chains.
As a result, inflation is becoming stickier. Businesses reported that non-labor input costs are rising faster than the prices they are able to charge, leading to margin compression and uneven pricing power across sectors. This dynamic suggests that even if energy prices stabilize, the second-round effects embedded in transportation, packaging, and agricultural inputs may persist, keeping underlying inflation elevated. At the same time, the broader economic backdrop remains mixed: Growth continues at a modest pace across most regions, but consumer behavior is increasingly strained—particularly among middle- and lower-income households—and the labor market remains subdued in a “low-hire, low-fire” environment. Put simply, the Beige Book points to an economy that is still expanding but facing a more entrenched and diffuse inflation problem where the spillovers beyond energy are what ultimately make price pressures more persistent.
Hiring reaccelerates and broadens as revisions boost momentum, wages continue to cool
The latest jobs report from the Bureau of Labor Statistics (BLS) showed payrolls increasing by 172,000 in May, with the prior two months revised higher by a combined 93,000, pushing the three-month average up to a stronger 188,000, a notable turnaround from much weaker readings of -4,300 in February 2026 and -44,600 in October. Private payrolls rose a still solid 120,000, with the three-month average at 166,000, also rebounding sharply from 8,300 in February 2026 and 0 in August 2025, a period that helped prompt the Fed’s rate cuts. Importantly, hiring is becoming broader based, with the diffusion index staying above 50 for the fifth straight month, rising to 54.4 in May after spending nine of 12 months below 50 in 2025, indicating a larger share of industries are adding jobs. Meanwhile, the household survey showed its first employment gain of 2026, with 149,000 people added to employment, while 83,000 entered the labor force, leaving the unemployment rate unchanged at 4.3 percent. Wage growth came in at 0.3 percent month over month and 3.4 percent year over year, marking the slowest annual pace since 2021 and suggesting some continued cooling in labor cost pressures even as hiring remains relatively firm.
Manufacturing reaccelerates as demand surges, but inflation and labor risks persist
The May 2026 ISM Manufacturing Index painted the picture of a manufacturing sector transitioning from a slower, uneven recovery into a more durable expansion phase: 16 of 18 manufacturing industries expanded, with all six major drivers growing simultaneously to signal a widespread economic recovery.
Headline PMI rose to 54.0 from 52.7 in April, a 1.3-point increase and its highest level since May 2022, signaling that activity in the sector is not only expanding but doing so at a faster pace. Demand was the primary driver of that improvement, as the New Orders Index climbed to 56.8 from 54.1, a sizable 2.7-point gain, while the Backlog of Orders increased to 52.2 from 51.4, reflecting strengthening pipelines and suggesting demand is beginning to outpace current production capacity. Production itself moved higher as well, with the Production Index rising to 54.3 from 53.4, a 0.9-point increase, indicating that firms are responding to improved demand by ramping up output. At the same time, the improvement remains uneven beneath the surface. The Employment Index rose to 48.6 from 46.4, a 2.2-point increase, but remained below the key 50 threshold, signaling that manufacturing employment continues to contract, albeit at a slower pace.
Inventory readings also highlight a more nuanced dynamic. The Inventories Index inched up to 49.9 from 49, still technically in contraction but closer to stabilization, while the Customers’ Inventories Index increased to 42.7 from 39.1, remaining firmly in “too low” territory—suggesting that end demand may continue to support future production as businesses look to rebuild stock levels. However, inflationary pressures remain a central challenge. The Prices Paid Index declined modestly to 82.1 from 84.6, a 2.5-point decrease, but still signals a rapid pace of cost increases for manufacturers, underscoring that pricing pressures remain elevated even as they show tentative signs of easing. Meanwhile, the Supplier Deliveries Index held steady at 60.6, unchanged from April, indicating that supply chains remain constrained, with slower delivery times typically consistent with stronger demand conditions.
Services activity expands on strong demand but hiring lags as price pressures build
The ISM Services Index also pointed to a continued expansion in economic activity in May, supported by firm underlying demand and rising activity levels. Seventeen of 18 industries expanded, improving from 14 in April. But like manufacturing, inflationary and employment pressures persist.
Headline services PMI rose to 54.5 from 53.6 in April, a 0.9-point increase and the 23rd consecutive month of growth, reinforcing the idea that the largest part of the economy remains on solid footing. That strength was driven by a notable acceleration in demand, as the New Orders Index increased to 57.3 from 53.5, a 3.8-point gain, while the Business Activity Index rose to 57.7 from 55.9, a 1.8-point increase, suggesting service providers are seeing both stronger incoming demand and a corresponding pickup in current activity.
However, like what we see in the manufacturing sector, the details point to an uneven picture. The Employment Index declined slightly to 47.9 from 48, a 0.1-point decrease, marking a third consecutive month of contraction and underscoring that hiring remains a clear weak spot despite stronger demand conditions. At the same time, cost pressures continue to run higher, with the Prices Index increasing to 71.3 from 70.7, a 0.6-point rise and its highest level since August 2022, highlighting that inflationary forces remain firmly embedded across the services side of the economy.
AI drives layoffs higher as workforce restructuring picks up
The latest Challenger job cuts report reinforces the theory that the labor market is beginning to potentially reflect a real-time shift driven by AI adoption, at least in the technology industry, which had the highest number of job cut announcements. U.S. employers announced 97,006 job cuts in May, the highest level for that month since 2020 and the third straight monthly increase, signaling a renewed uptick in layoffs. What stands out, however, is not just the level of cuts, but the composition: AI was the leading reason cited for layoffs for the third consecutive month, accounting for roughly 40 percent of all job cuts, or about 38,000 positions.
This brings the year-to-date job cut announcement total to 397,755, which is meaningfully below the 696,309 announcements last year through May 2025. However, when you strip out the one-time reduction of 284,044 government jobs by the U.S. Department of Government Efficiency (DOGE), the year is only slightly below last year’s adjusted number of 412,265 through May. Technology leads the year-to-date industry count at 123,653 up from last May’s year-to-date number of 74,716. AI is now the leading cause for job cuts in 2026 with 87,714 job cuts, or 22 percent of total reductions—already surpassing the 54,836 AI-related job cuts for the entirety of 2025. A logical question remains: Are these jobs truly being eliminated by AI, or do they reflect the reality of the rising costs to bring AI to life, with layoffs needed to support continued spending? Hiring remains historically low, with U.S. employers announcing a mere 80,472 hires year to date through May, up slightly from the 79,741 at this same point in May 2025.
The week ahead
Monday: The Federal Reserve Bank of New York will publish its May 2026 Survey of Consumer Expectations next week at 11:00 a.m. EST, including data on consumers’ perceived probability of missing a minimum debt payment over the next three months. In April, the expected probability of missing a minimum debt payment dropped by 0.9 percentage points to 11.4 percent, its lowest level in over two years. However, the May data is expected to show a potential uptick in this fear, as high food and energy costs throughout May likely squeezed household cash flows.
Tuesday: The National Association of Realtors will publish the Existing-Home Sales data at 10:00 a.m. EST. April inched up by a modest 0.2 percent to a seasonally adjusted annual rate of 4.02 million units. This slight recovery could reverse, however, as mortgage rates have climbed in May, triggering renewed buyer gridlock.
Wednesday: The BLS will publish the May 2026 CPI data at 8:30 a.m. ET. April’s report showed inflation jumping to 3.8 percent annually, the highest reading in three years. We will be looking at the May data to see if these price pressures have begun to stabilize or are continuing to accelerate.
Thursday: Next up, the BLS will publish the May 2026 Producer Price Index (PPI) data at 8:30 a.m. ET. We will be paying close attention to core PPI—the Fed’s preferred inflation gauge that strips out more volatile food and energy sectors—projected to increase by 0.5 percent month –over month following a steep 5.2 percent annual reading in April.
Separately on Thursday, the U.S. Department of Labor will publish its next weekly Initial Jobless Claims report at 8:30 a.m. ET. The prior report (for the week ending May 30) showed a surprise jump of 13,000 filings, pushing initial claims up to 225,000, the highest level of weekly layoffs in four months. We will be monitoring for more signals that the historically tight labor market may be starting to cool.
Friday: The preliminary University of Michigan Consumer Sentiment data for June 2026 is set to be published at 10:00 a.m. ET. Last month’s final consumer sentiment index plunged to a record low of 44.8. We will be watching the June early reading, which is expected to rise to 47.6, for signs of whether consumer fears have begun to ease or if long-run inflation expectations (which hit 3.9 percent in May) have remained elevated.
Brent Schutte, CFA, is chief investment officer of the Northwestern Mutual Wealth Management Company.
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