Repricing the Economy
Behind the scenes, there's been a shift in the macroeconomic narrative. It's been building over the past year, not just in the last month.
When the war in Iran began, oil prices, inflation, and Treasury yields shot up, and U.S. stocks fell. Then the tide turned as hopes for a resolution in the conflict began to build. Since then, however, things have diverged a bit: Oil prices finished May near their war lows and the S&P 500 broke record high after record high. But Treasury yields are near 12-month highs and inflation fears have intensified. The University of Michigan's consumer sentiment index fell to an all-time low in May amid the cost-of-living pressures.
What's going on? Investors have come to realize that labor markets, domestic demand, corporate pricing power, nonstop AI investment — all of it — are combining to power "can't stop, won't stop" economic momentum that has buried hopes for lower interest rates, regardless of how dour consumers may feel.
The Federal Reserve and newly confirmed Chair Kevin Warsh are staring down the barrel of overheating as multiple months of strong jobs data gives the employment side of the Fed's dual mandate new urgency. That has contributed to fed funds futures now implying an 83% probability of an interest rate hike by January, a far cry from the two to three rate cuts priced in before the war.
Can't Stop, Won't Stop
It turns out that what's bad news for the bond market doesn't have to be bad news for the stock market. Though rising Treasury yields can eventually be viewed as an anchor on valuations, investors spent most of May focusing on the upside of economic growth.
This is not hard to do when company fundamentals are as good as they were in the first-quarter earnings season. Earnings growth accelerated to 26% y/y — significantly above expectations — as 84% of S&P 500 constituents surpassed consensus estimates. Still, it should be said that the bulk of the surprises were concentrated in AI-sensitive names, with the hyperscalers and broader Information Technology sector clear leaders.
Given debt is becoming an increasingly important part of capital expenditures, rising borrowing costs may start to serve as a limiting factor. But so far, profits are more than offsetting it in the minds of investors.
Of course, this goldilocks dynamic is probably unsustainable. Investors are cheering for strong nominal growth despite the potential for higher interest rates, but as we've seen in prior overheating episodes, there will probably come a point where "good news" becomes "bad news" and the Fed signals a tightening in financial conditions to reel in the economy. There are growing signs of such overheating, but it doesn't look like we're there yet.
Market Recap
Macro
• Kevin Warsh was officially sworn in as Federal Reserve Chair.
• The April employment report showed 115,000 jobs added, nearly double consensus estimates, and slightly slower wage growth than expected at 3.6% y/y.
• Oil prices declined by 16.9% on hopes for a peace deal and end to the Iran conflict.
• The Consumer Price Index rose 0.5% m/m, driven by the increase in energy prices. The annual consumer inflation rate increased to 3.8%, a multi-year high.
• The Producer Price Index surged 1.4% m/m, far above consensus estimates, bringing the annual wholesale inflation rate to 6.0%.
• The University of Michigan's Consumer Sentiment declined to an index value of 44.8, the lowest on record.
• For the second month in a row, copper rose 5.3% to $13,600/mt, as the AI buildout shows no signs of slowing.
Equities
• The S&P 500 rose 5.3% to finish the month at an all-time high of 7,580.
• Despite the strong month, 10 of 11 sectors underperformed the broad index; the S&P 500 was boosted by an extremely strong 16.0% gain by the Information Technology sector.
• 84% of companies in the S&P 500 beat consensus expectations, the highest mark since the second quarter of 2021.
• Growth stocks outperformed value stocks by 4.2 percentage points, their best relative performance since May 2025.
• In what has been a pattern for most of 2026, emerging markets outperformed U.S. and international developed markets on the strength of South Korean and Taiwanese stocks.
Fixed Income
• Though bonds finished the month in positive territory, Treasury yields rose as much as 25-30 basis points across the curve before ending the month up just 5-10 basis points, with shorter-term maturities up more.
• U.S. TIPS beat nominal Treasurys by 0.3 percentage points, as inflation concerns led to increased demand for inflation protection.
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