Market Update
U.S. equity markets saw a big reversal last week, as higher rate expectations combined with a pullback in semis caused major indices to end the week down. The stronger than expected jobs report shifted rate expectations, with the market now pricing in a high likelihood of a rate hike by the end of the year versus expecting rates to remain unchanged. Additionally, no major update on the progress of an agreement between the US and Iran didn’t help markets either. Treasury yields increased again on the back of a strong jobs number amid growing concerns around inflation. This week is going to be an interesting week, with the long-anticipated SpaceX IPO slated for Friday. Some expect to see a sell-off in certain overbought names in order to fund SpaceX stock purchases.
May Jobs Report
The May jobs report delivered a broadly positive surprise. The 172k increase in nonfarm employment came in significantly above expectations, was broad-based, and came along with upward revisions to prior months’ estimates. April's figures were revised up by 64k and March by 24k, lifting the three-month average to a healthy 188k jobs per month. Government hiring was up 52k while private employment added 120k jobs. Leisure and hospitality was the standout industry in the private sector, adding 70k jobs — its strongest single-month gain in more than three years, potentially boosted by early World Cup-related activity.
Other labor market indicators were mostly in line with expectations. The unemployment rate held steady at 4.3%, and average hourly earnings were w up 0.32% month-over-month, albeit bit lower than 0.4% consensus. On an annualized basis, wage growth came in at 3.4%, down from April's 3.6%, and the three-month annualized average decelerated to just 3.1% - the softest reading of the current expansion. One area of continued concern: the long-term unemployed (those out of work for 27 weeks or more) rose again to nearly 2 million, now representing almost 28% of all unemployed workers. In addition, the recent concentration of job gains among production and nonsupervisory workers may be consistent with the broader narrative that hiring remains stronger in services, hospitality, and blue-collar industries than in some white-collar ones, where companies may be more cautious amid accelerating adoption of AI productivity tools. Given that the report was overall strong, a resilient labor market may warrant a change in the Fed’s monetary policy outlook, particularly if inflation becomes sticky.
Is AI inflationary or deflationary, and how does it affect monetary policy?
The effect of AI on inflation depends on the time horizon. In the near term, AI is putting upward pressure on inflation due to increased spending on data center infrastructure, higher electricity costs, and software hikes following deployment of AI tools. These dynamics could flip over the medium term as AI tools begin to deliver productivity gains that could lower the costs of production. This interplay creates a complex challenge for monetary policy. In the immediate future, AI investment acts as a demand shock where the massive influx of capital drives up specific input costs. To prevent this surge from spilling into broader economy wide inflation, the Fed may keep the nominal rates higher for longer. In the medium term, if the supply side promise of AI delivers, it transforms into a productivity shock where cost of labor and production should fall. This may allow central banks to safely lower interest rates to support a higher capacity economy.
Broadcom Sparks Semiconductor Sell Off
AVGO, one of the central suppliers for ASICs and custom silicon, reported strong earnings after the bell on Wednesday; however, markets fixated on the softer-than-expected revenue guidance for AI chips of $16 billion, versus the street expectation of $17.2 billion for the July quarter. The market reaction initially was negative, with the stock falling roughly 15% following earnings; however, shares had rallied for three consecutive days heading into the report, adding approximately $270 billion in market capitalization, and by the close of last week were only a few percentage points below their pre-earnings level. The reason for the miss on AI revenue was mainly due to backlog taking longer to convert to revenue than anticipated, with Anthropic’s shift from solely ordering chips to entire server racks being cited as a central reason for the miss. Besides the AI revenue miss, the company beat on both the top and bottom line, but the growing gap between an AI backlog of $30 billion and AI revenue of $10.8 billion shows that demand is present, yet the conversion of orders into revenue is lagging market expectations. The demand picture becomes clearer when taking into account that AVGO has signed multi-year agreements with Google, OpenAI, Anthropic, and Meta to deliver multiple gigawatts of compute capacity through 2028. Regardless, the broader market still interpreted AVGO's results as a bellwether for AI-related firms' ability to convert backlog into revenue, but another reason behind the semiconductor selloff may have been a rotation into other underappreciated sectors. Healthcare and financials have been sectors to catch a bid post-AVGO earnings, but the looming SpaceX IPO on June 12th may also be prompting investors to trim some semiconductor exposure to reallocate to the highly anticipated IPO.
Sources:
https://markets.jpmorgan.com/jpmm/research.article_page?action=open&doc=GPS-5324893-0
https://markets.jpmorgan.com/jpmm/research.article_page?action=open&doc=GPS-5326748-0
https://www.bls.gov/news.release/pdf/empsit.pdf
https://markets.jpmorgan.com/jpmm/research.article_page?action=open&doc=GPS-5328014-0
https://www.cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html
