Maintaining a risk-on stance in U.S. stocks

A cooling labor market could spur more Fed rate cuts

Motivated by worries about the softening labor market, the Fed cut rates last month – cuts that underpin our pro-risk stance, as we outlined in our Q4 Global Outlook. Job growth has run below 200,000 a month this year, and unemployment has edged higher. The slowdown likely reflects tariff uncertainty, as companies wait for clarity, and federal job cuts, with about 100,000 jobs lost so far and more ahead.

Labor supply has also weakened: The Congressional Budget Office now expects net immigration of 400,000 in 2025 versus a January estimate of 2 million. The result: Labor demand has slowed sharply, but the “breakeven” pace of job growth – keeping unemployment and wage gains in check – has also fallen notably (see the chart below). In other words, yes, job gains are slowing, but job losses are muted, with the unemployment rate low by historical standards – a “no-hiring, no firing” stasis.

For the Fed, this combination of weaker payroll gains and slowing inflation from softer labor demand has mitigated the tension between its inflation and employment mandates, justified the September rate cut, and allowed it to signal scope for more cuts.

Questions about Fed independence and fiscal dominance are on the backburner for now. But the government shutdown that started on Oct. 1 deprives the Fed of important monthly payrolls data – just as that data become even more critical for its decisions. In its absence, policymakers and investors have latched onto other proxies – including the job openings (JOLTs) report released just before the shutdown, the private-sector ADP jobs report and state-reported weekly jobless claims – for a picture of the market. We think they’ll keep using these proxies until federal data releases return.

Several possible paths ahead

The shutdown and missing data haven’t prevented markets from pricing for two further quarter-point cuts this year. We agree, provided the labor market keeps slowing. But beyond this year, we see several possible paths for activity and the labor market.

In our base case scenario, resilient household incomes fuel a recovery in consumer spending. On top of this, large-scale investment stemming from the AI buildout – in tech equipment, software, and data centers – drives growth. This scenario wouldn’t warrant the more than 100 basis points of rate cuts that markets have priced in by the end of 2026, in our view. That degree of policy easing would typically be associated with a more severe weakening in the labor market and drop in inflation. A sharp deterioration in U.S. growth looks less likely now, given the recent rebound in consumer demand.

A plausible alternative to our base case? A hiring rebound as peak tariff uncertainty passes and strong GDP growth puts the Fed back in a bind between inflation and employment, reviving questions about its independence – a possibility that shows why reliable labor market data is critical now.

The September cut, expected quarter-point cuts later this year, and ongoing AI capital investments support our long-held tactical overweight to U.S. equities and the AI theme. We also see an opportunity to lock in higher yields, particularly real yields, with U.S. 10-year real yields holding well above pre-pandemic levels.

Our bottom line

Our overweight to U.S. stocks depends on resilient activity and a cooling labor market spurring more Fed rate cuts. We stay neutral Treasuries, having closed a long-held underweight to long-term Treasuries as the Fed resumes cuts.

Wei Li, Managing Director, is the Global Chief Investment Strategist at BlackRock Investment Institute at BlackRock Inc.

Jean Boivin, Head – BlackRock Investment Institute, Glenn Purves, Global Head of Macro – BlackRock Investment Institute, and Nicholas Fawcett, Senior Economist – BlackRock Investment Institute, contributed to this article.

Disclaimer

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