The Labor Market’s Slow Rebalancing: Wage Disinflation Meets a Normalizing Yield Curve

Equities are leaning into a benign growth/disinflation mix with breadth that extends beyond megacap tech. Over the past month, 1-month total return proxies from close-to-close show SPY ~+3.7%, QQQ ~+4.6%, DIA ~+1.3%, IWM ~+3.4%, EFA ~+4.1%, and EEM ~+3.9%, using Yahoo Finance data. The level of implied equity risk remains moderate, with the VIX near 15.7 and well below stress regimes, per Cboe/Yahoo Finance.

Rates markets have re-priced to a positively sloped curve as policy approaches a transition from restrictive to less restrictive. On-the-run yields show 2Y at 3.75%, 5Y 3.85%, 10Y 4.33%, and 30Y 4.92% (U.S. Treasury, 2025-08-15). That leaves 2s10s at +58 bps and 2s30s at +117 bps, consistent with a normalization after a prolonged inversion. Market-implied inflation compensation remains steady: 5y breakeven ~2.42%, 10y ~2.38%, and 5y5y forward ~2.34% (FRED: T5YIE, T10YIE, T5YIFR). Real rates remain elevated with the 10-year TIPS yield around 1.9% (FRED: DFII10), while IG and HY spreads are contained near ~77 bps and ~289 bps, respectively (FRED: BAMLC0A0CM, BAMLH0A0HYM2).

Cross-asset signals from commodities point to less pressure on headline inflation and corporate energy inputs. Front-month WTI settled near $63.05 (down ~5% over one month), natural gas near $2.80 (down ~20%), copper near $4.47 (down ~19%), and gold near $3,394/oz (up ~2%) (Yahoo Finance). In aggregate, the commodity complex reduces near-term headline CPI volatility relative to earlier in the year, particularly given oil’s retracement. In rates, the MOVE index recently moderated from earlier spikes (FRED), consistent with tighter ranges and improved liquidity after a period of heightened duration risk.

The wage-price backdrop continues to normalize. Average Hourly Earnings (AHE) rose to $36.44 in July, up ~3.9% YoY, with monthly gains modest (BLS/FRED: CES0500000003). Average weekly hours remain stable at ~34.3 (FRED: AWHAETP), helping anchor labor income growth even as hiring cools. The unemployment rate is near 4.2% with the prime-age (25–54) employment-to-population ratio at ~80.4% (FRED: LNS12300060), signaling high utilization of core labor supply. Labor force participation is broadly steady, and the employment-population ratio remains supportive of consumption.

Labor demand continues to rebalance. JOLTS openings declined to ~7.44 million in June, hires near ~5.20 million, quits around ~3.14 million, and the quits rate ~2.0% (FRED: JTSJOL, JTSHIL, JTSQUL, JTSQUR). Weekly initial claims have hovered around ~224k (week ended Aug. 9), signaling softer but not collapsing labor demand (FRED: ICSA). This is consistent with a gradual rotation from excess demand toward better matching efficiency along the Beveridge curve, which historically reduces wage pressure without requiring a deep rise in unemployment.

Inflation has cooled but remains sticky in core services. Headline PCE was ~2.6% YoY in June, with core PCE ~2.8% YoY (FRED: PCEPI, PCEPILFE). CPI in July was ~2.7% YoY with core CPI ~3.0% YoY (FRED: CPIAUCSL, CPILFESL). Alternative measures suggest underlying inflation is trending toward, but not yet at, 2%: the Dallas Fed trimmed-mean PCE 12-month rate is ~2.6% (FRED: PCETRIM12M). Market-based inflation expectations (5y and 10y breakevens and the 5y5y forward) are clustered near 2.3–2.4% (FRED), consistent with a soft-landing path if wage disinflation persists and productivity holds up (FRED: OPHNFB, ULCNFB).

The effective federal funds rate remains around 4.33% (FRED), while the July 30 FOMC statement emphasized balanced risks and continued progress on inflation, maintaining a data-dependent posture (Federal Reserve, July 30, 2025). The June SEP medians point to core PCE at 3.1% in 2024, 2.4% in 2025, and 2.1% in 2026; GDP growth close to potential; unemployment around the mid-4s; and the median policy rate drifting from 3.9% (2024) toward 3.6% (2025) and 3.4% (2026), with 2027 around 3.0% (FOMC SEP, June 18, 2025). That path is consistent with a slow pivot from restrictive to neutral over multiple meetings rather than a rapid easing sequence.

Term structure dynamics corroborate this: the curve has steepened with 2s10s ~+58 bps and 2s30s ~+117 bps (Treasury), while the 10-year TIPS yield near ~1.9% (FRED/NY Fed style real-rate proxies) implies tight real financing conditions compared with the pre-pandemic norm. Market-implied inflation compensation (5y/10y breakevens near 2.4%/2.38%) signals inflation expectations remain anchored (FRED). Minutes from June (released July 9) stressed the Committee’s sensitivity to services inflation and wage trends amid cooling demand (Federal Reserve minutes).

Balance sheet and money-market signals also argue for gradualism. The Fed’s balance sheet (WALCL) is ~6.64 trillion and the ON RRP facility has wound down to tens of billions from prior peaks (FRED: WALCL, RRPONTSYD). Credit conditions remain benign with IG OAS ~77 bps and HY OAS ~289 bps (FRED), reducing the need for policy to offset acute funding stress. Together, policy communication and market pricing suggest a baseline of measured easing contingent on further evidence of sustained disinflation and labor rebalancing.

Equities appear to be pricing a soft landing: cyclicals have stabilized while growth remains leadership but not to a euphoric extent. Sector performance has been mixed recently, with Energy showing resilience, Health Care steady, and rate-sensitive sectors (Utilities, Financials, REITs) reacting to curve steepening and higher real rates (per Financial Modeling Prep sector data). With gold firm and oil softer (Yahoo Finance), headline inflation risk premia have eased, tailwinds for multiples in rate-sensitive growth and for margins in energy-intensive industries.

In rates, the positive curve slope and elevated real yields improve pension discount rates and the attractiveness of carry in the belly. A measured duration stance—favor 5–10y for roll-down with some 30y as convexity/deflation hedge—fits current dynamics. Credit risk premia remain contained (IG ~77 bps; HY ~289 bps, FRED), but vigilance is warranted given refinancing needs and supply. The MOVE index’s recent moderation (FRED) suggests better liquidity/positioning after episodic spikes. For equities, we monitor earnings sensitivity to wages: with AHE growth near 3.9% YoY and energy costs lower, margin pressures from labor and commodities look manageable. Internationally, EAFE and EM rebounded over the past month, aided by dollar stability and improving global disinflation (Yahoo Finance; FRED breakevens). Cross-asset ratios (QQQ/SPY, SPY/GLD) continue to favor growth over value and risk-on over risk-off, albeit with narrower leadership breadth than 2023–24 (Financial Modeling Prep ratios).

Base case (60%): Soft landing. AHE slows toward 3.5–3.7% YoY by mid-2026; openings trend to ~7.0 million; unemployment 4.3–4.6%; core PCE drifts to ~2.3–2.5% in 2025–26; 10-year UST ~3.9–4.4% with 2s10s +30 to +80 bps. Policy path: one to two cuts over the next two meetings, then data-dependent pauses consistent with the SEP medians. Market implications: positive carry in belly, moderately constructive equities with factor tilt toward quality growth, AI enablers, and health care; modest underweight deep cyclicals until CapEx re-accelerates.

Hawkish risk (25%): Services/core sticky. Core PCE stalls near ~2.8–3.1% through mid-2026; wage growth stabilizes ~4.0%; unemployment 4.6–4.9%. Policy: fewer/further-out cuts; real rates stay high; term premium rises on supply/term-structure volatility. Market: curve bear-steepening; pressure on long-duration assets (REITs, utilities), defensives favored; IG preferred over HY as funding costs bite.

Dovish risk (15%): Growth downshift. Payrolls and openings slow more abruptly, unemployment rises to ~5.0–5.3%; core PCE glides quickly toward ~2.1–2.3%. Policy: quicker sequence of cuts; curve bull-steepening as front-end leads. Market: duration outperforms, long-end rallies; quality duration equities (software, semis with secular growth) perform; HY spread widening but IG supported by lower risk-free rates.

Uncertainty bands: 68% intervals over the next 4 quarters—core PCE 2.2–2.9% (center ~2.5%); unemployment 4.2–5.0% (center ~4.6%); real GDP 0.7–2.2% (center ~1.5%), contingent on productivity gains and labor supply metrics (FRED/BEA; SEP ranges).