U.S. equities pushed higher during last week’s holiday shortened trading as cooling economic data, including a more tepid June jobs report, increased the odds of a September rate cut from the Federal Reserve. For the week, the S&P 500 and Nasdaq Composite marked new record highs following gains of 1.95% and 3.50%, respectively, while the Dow Jones edged 0.6% higher. Large cap tech stocks continued to be the major driver of the stock market rally, which has driven a historic dispersion in returns between U.S. large cap stocks and small cap stocks. In fact, the small cap Russell 2000 index fell -1.0% last week and is now just about flat on the year compared to the S&P 500’s 17.6% year-to-date total return. An equal-weighted version of the S&P 500, which has lower weightings to mega-cap tech stocks than the traditional market-cap weighted S&P 500, is up less than 5% so far this year.

The June jobs report maintained the path of gradually loosening labor market conditions as an upside surprise in net new June payrolls (rose 206k vs. the consensus forecast of 190k) was more than offset by a downward revision of the April and May results totaling 111k. Additionally, the unemployment rate ticked higher to 4.1% compared to 4.0% in May and the cycle low of 3.4%, and wage growth decelerated from 4.1% to 3.9% (the smallest gain since 2021). Historically, a rising unemployment rate is a warning flag as labor market conditions can go from strong to weak in short order, and the rise is often difficult to contain as job loss and income loss become a negative reinforcing cycle. However, it is important to note that an increase in the labor force (+277k workers) was a larger driver of June’s uptick than layoffs, which totaled 162k, and the unemployment increase has been concentrated to younger workers, whose joblessness rate tends to be more volatile from month to month.

While inflation remains in the crosshairs of the Federal Reserve, the central bank is becoming increasingly focused on the downside risks to the labor market from its restrictive policy position. For months, the Fed has pointed to the tight labor market as a sign that economic conditions were overstretched, but the recent job data points are starting to make the case for easing policy conditions soon to head off an acceleration in job losses. The market probability for a September rate cut increased to over 72% last week from just 50/50 odds a month ago, according to the CME FedWatch Tool. Rate cuts are still contingent on falling inflation, but May’s inflation results were a step in the right direction.

With that backdrop, this week’s June CPI inflation report (due out Wednesday) is of high importance in determining the next step for the Fed. If CPI is cooperative, the odds of a September rate cut will increase further. The consensus forecast is for the annual growth rate of headline CPI to decelerate from 3.3% to 3.1%; however, core CPI growth (excluding food and energy prices) is expected to stay steady with the prior month at 3.4%.

This week will also kick off the second quarter corporate earnings season with several large financial institutions on deck to report first at the end of the week. The bar has been set high for second quarter earnings to continue to accelerate. Analyst consensus forecasts for the members of the S&P 500 imply expectations for an 8.8% year-over-year increase in earnings, which would be the highest growth rate since the first quarter of 2022, according to FactSet.