The Fed's Impossible Choice: When Economic Policy Hits a Wall

Executive Summary

The S&P 500 finished the week down 0.39%, moving from optimism driven by positive economic data to caution in reaction to tariff news and heightened geopolitical tensions.

Key Economic Theme

The U.S. economy displayed mixed signals this week, with labor market softening becoming the dominant concern while inflation pressures showed signs of stabilizing. Consumer confidence improved significantly as tariff fears began to ease, though geopolitical tensions emerged as a new risk factor.

Critical Labor Market Developments

Employment momentum slowed dramatically. Private sector job creation fell to just 37,000 positions in May—the weakest pace in over two years—while unemployment claims reached eight-month highs. More concerning, continuing claims surged to 1.96 million, the highest since November 2021, indicating unemployed workers face longer job searches. This combination suggests employers are exercising hiring restraint while workers struggle to find new positions.

Consumer Sector: Tale of Two Demographics

Spending patterns revealed a stark generational divide. Overall consumer spending growth decelerated to 0.8% year-over-year, but older consumers maintained robust spending while younger households pulled back despite stronger wage growth. Gen Z and Millennials face mounting pressure from housing costs, student loans, and childcare expenses, driving increased reliance on buy-now-pay-later financing. This divergence complicates economic forecasts as younger demographics represent tomorrow's primary consumption engine.

Business Sentiment and Inflation Outlook

Small business optimism rebounded strongly to 98.8 in May, returning above the 51-year average. Notably, inventory levels hit their lowest point since August 2022, suggesting either robust demand or supply chain efficiency gains. Producer-level inflation remained contained with May PPI rising just 0.1% monthly, while consumer inflation expectations declined across all time horizons.

Geopolitical Risk Factor

Markets faced pressure Friday following Israeli strikes on over 100 Iranian targets, including nuclear facilities. Oil prices jumped 6% amid supply disruption concerns, highlighting how geopolitical tensions can quickly overshadow economic fundamentals.

THE FED'S IMPOSSIBLE CHOICE

Markets have rallied from their "Liberation Day" lows on expectations that easing inflation would enable Federal Reserve policy accommodation. However, Middle East conflict threatens to drive oil prices higher, and energy represents a significant inflation component. With the economy slowing over the past year and labor markets now showing recent signs of softening, rising energy costs combined with tariff impacts could force the Fed to maintain restrictive policy longer than markets anticipate. This combination of slowing growth and persistent inflation mirrors stagflationary conditions that historically challenge both corporate earnings and equity valuations. The Fed's dual mandate of price stability and maximum employment becomes impossible to fulfill simultaneously, forcing policymakers to choose between tolerating higher inflation or accepting higher unemployment.

Monday: 

Wholesale Inventories Edge Up - Wholesale inventories climbed 0.2% in April to $908.7 billion, revised up from the Census Bureau's initial flat estimate. Year-over-year growth hit 2.3%. The real story emerges when comparing inventory growth against sales. Wholesale sales surged 6.0% annually while inventories grew just 2.3%—indicating strong demand without the buildup that typically signals economic weakness. This balance matters because wholesale inventory levels often preview broader economic trends. When inventories pile up faster than sales, it suggests slowing demand and potential production cuts ahead. April's data shows the opposite: controlled inventory growth alongside robust sales. The inventory-to-sales ratio of 1.30 improved from 1.34 a year ago, suggesting healthy underlying demand that should support earnings across consumer goods and manufacturing companies. - Source: U.S. Census Bureau

Consumer Confidence Builds as Inflation Fears Cool - The New York Fed's May consumer survey delivered encouraging news: Americans expect inflation to moderate across all time horizons. One-year expectations dropped to 3.2%, three-year to 3.0%, and five-year to 2.6%—with notably tighter consensus among respondents. Labor market sentiment improved alongside inflation optimism. Consumers expect wage growth of 2.7% while seeing reduced unemployment risk—the probability of higher joblessness in a year fell to 40.8%. Job loss fears declined to 14.8%, even as voluntary quit intentions rose to 18.3%, suggesting workers feel confident enough to change jobs. Housing and financial outlooks also brightened. Home price growth expectations moderated to 3.0%, and consumers reported improved views on debt delinquencies and household finances. This convergence—cooling inflation expectations, stronger labor confidence, and improved financial outlooks—creates favorable conditions for continued economic expansion. - Source: NY Fed Survey of Consumer Expectations

Tuesday:

Small Business Optimism Rebounds - Small business optimism climbed to 98.8 in May, beating forecasts and returning above the 51-year average for the first time in three months. The NFIB index jumped 3 points as sales expectations and business conditions outlook improved significantly. The standout development: inventory levels hit their lowest point since August 2022, with a net 1% viewing stocks as "too low"—the largest monthly increase in survey history. This inventory squeeze suggests either stronger-than-expected demand or supply chain efficiency gains. Labor markets remain tight with 34% reporting unfilled job openings, though concerns about labor quality as the top business problem eased. More tellingly, taxes emerged as the primary concern for 18% of owners—the first time since December 2020 taxes topped the list. Improving sales expectations and inventory depletion typically signal accelerating demand ahead, though the tax focus may create policy headwinds. - Source: NFIB Small Business Economic Trends

Bank of America Consumer Spending Shows Generational Divide - Consumer spending momentum stalled in May as Bank of America card data revealed a stark generational divide. Overall spending per household grew just 0.8% year-over-year, down from 1.0% in April, with seasonally adjusted spending declining 0.7% month-over-month. The weakness stemmed from falling gas prices, payback from earlier tariff-driven purchases, and poor weather dampening Memorial Day activity. But the deeper story lies in demographic patterns: older consumers maintained robust spending growth while younger households pulled back despite stronger wage growth. Gen Z and Millennials face mounting pressure from housing costs, student loan payments, and childcare expenses—costs largely paid outside traditional card spending. These financial strains are driving increased reliance on buy-now-pay-later financing, with BNPL usage accelerating among younger demographics. This divergence complicates consumption forecasts. While older consumers with retirement income drive current spending, younger households' financial constraints could limit future economic expansion as they represent tomorrow's primary consumption engine. - Source: Bank of America Institute Consumer Checkpoint

Wednesday:

ADP Employment Report Signals Hiring Slowdown - The ADP National Employment Report showed U.S. private sector employment increased by just 37,000 jobs in May—the slowest pace since March 2023 and well below expectations of 110,000 jobs. Manufacturing shed 3,000 positions, consistent with ongoing sector weakness, while companies employing fewer than 50 workers lost 13,000 jobs. Despite weak hiring momentum, wage growth remained robust at 4.5% for job-stayers and 7.0% for job-changers, unchanged from April levels. The hiring deceleration primarily affected goods-producing industries, which lost 2,000 positions overall, while services added 36,000 jobs led by leisure and hospitality. The report suggests employers are showing hiring hesitancy amid policy uncertainty and mixed economic signals, though robust wage growth indicates the labor market remains fundamentally stable. - Source: ADP National Employment Report, May 2025, released June 4, 2025

Services Sector Contracts for First Time Since June 2024 - The Institute for Supply Management's Services PMI fell to 49.9 from 51.6, missing expectations of 52.0 and marking the first contraction since June 2024. New orders plunged to 46.4, while the prices index surged to 68.7—the highest since November 2022, reflecting tariff-related cost pressures. S&P Global's Services PMI rose to 53.7, creating confusion about the sector's true direction. The divergence between the two surveys highlights uncertainty among businesses, though both noted price pressures from tariffs. ISM's report suggested broader hesitancy, while S&P Global indicated modest expansion from April's low base. The conflicting signals complicate economic assessment, but both surveys agreed on mounting inflationary pressures that could influence Federal Reserve policy decisions. - Source: Institute for Supply Management, Services ISM® Report On Business®, May 2025, released June 5, 2025; S&P Global, S&P Global US Services PMI, May 2025, released June 4, 2025

Thursday:

US Jobless Claims Hold at 8-Month High as Unemployed Workers Struggle to Find New Jobs - Weekly initial claims for unemployment insurance reached 248,000, exceeding economist expectations of 242,000 and marking the highest level in eight months. More concerning was the surge in continuing claims, which increased by 54,000 to 1,956,000, representing the highest level since November 2021. This data indicates unemployed individuals are experiencing longer job search periods and suggests reduced hiring activity, even though termination rates haven't significantly increased, reflecting broader labor market softening amid economic uncertainty. - Source: Department of Labor

May Producer Prices Rise Modestly as Wholesale Inflation Pressures Remain Contained - Write a headline for this: The May 2025 Producer Price Index rose 0.1% month-over-month, with annual inflation at 2.6% year-over-year. Core PPI (excluding food, energy, and trade services) increased 0.1% monthly after declining 0.1% in April. The report indicates contained wholesale inflation pressures, with services contributing to the modest increase while sectors like jet fuel experienced significant declines, supporting continued moderation in producer-level cost pressures. Source: Bureau of Labor Statistics PPI report released June 12, 2025

Friday:

Consumer Sentiment Surges 16% as Tariff Fears Begin to Ease - The preliminary June 2025 University of Michigan Consumer Sentiment Index jumped 16% to 60.5, marking the first improvement in six months and significantly exceeding forecasts of 53.6. This represented the largest monthly gain since early 2024, driven by easing concerns about tariff impacts on the economy. Year-ahead inflation expectations declined from 6.6% to 5.1%—the lowest level in three months—while five-year expectations dropped from 4.2% to 4.1%. Survey Director Joanne Hsu noted that consumers appear to have "settled somewhat from the shock of the extremely high tariffs announced in April," though sentiment remains approximately 20% below December 2024 levels and inflation expectations stay elevated compared to late 2024 due to persistent trade policy concerns. - Source: University of Michigan Surveys of Consumers preliminary report released June 13, 2025.

Israeli Strikes Hit Over 100 Targets in Iran, Including Nuclear Facilities - Market came under pressure Friday in response to news that Israel had launched a large-scale military operation targeting more than 100 Iranian sites, including nuclear facilities and senior IRGC leadership. The strikes, part of what Israeli officials called Operation Rising Lion, killed top Iranian commanders and scientists, triggering a retaliatory missile barrage from Tehran. Oil prices jumped over 6% amid fears of disruption in the Strait of Hormuz, while airline routes across the region were diverted. The escalation rattled global markets and renewed concerns over Middle East stability. Diplomatic channels are now strained as world leaders urge restraint to prevent broader conflict.

By The Numbers

Employment Indicators

Employment data helps gauge whether consumers have jobs and money to spend. Consumer spending accounts for more than 70% of GDP.

Note: Values above 250K for the 4-Week Average, combined with rising unemployment, would signal a weakening economy. Next unemployment report: July 3, 2025. Source: Department of Labor

Economic Growth (Real GDP)

GDP growth provides a broad measure of overall economic activity and signals whether the economy is expanding or contracting.
Source: Bureau of Economic Analysis; Estimate from Federal Reserve Bank of Atlanta

Inflation Measures (CPI Year-over-Year)

Source: Bureau of Labor Statistics; May estimate from Federal Reserve Bank of Cleveland

Note: While inflation has moderated, new tariffs may cause temporary spikes in monthly data. Once tariffs have been in place for a full year, inflation should revert closer to the underlying trend.

Interest Rate Outlook

Current Fed Funds Rate: 4.25-4.50%

Note: Changes in monetary policy expectations reflect market participants' views on how the Fed will likely respond to shifts in inflation or employment.
Source: CME FedWatch Tool

Corporate Earnings Outlook (S&P 500 Estimates for 2025)

Source: S&P Dow Jones Indices

Disclosure:

This material is provided by Todd Van Der Meid, MBA, CFP®, through Rhino Wealth Management, Inc., a Registered Investment Adviser, solely for informational purposes. It is not intended as investment, tax, legal, or accounting advice. Investors should consult qualified professionals before making financial decisions.

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