Slowing Wage Growth: Could it Lead to a Fed Pause and Stock Market Rally?

The June 2025 report on hourly earnings has revealed an important turning point in the economy, with private nonfarm payrolls seeing only a slight 0.2% increase—much lower than the anticipated 0.3%. This slowdown follows a substantial 1.1% surge in May, and the year-over-year wage growth has also fallen to 3.7% from 4.2% since November 2023, indicating a significant change in inflation dynamics. This data could potentially redefine Federal Reserve policy expectations and create new opportunities for investors in the equity markets.

The Federal Reserve has typically regarded wage inflation as a critical indicator of price stability. The latest data from June, accompanied by a decrease in the workweek to 34.2 hours (0.1 hours less than May), suggests that labor costs are decreasing without major job losses. This scenario presents a delicate balancing act for policymakers, where inflation pressures are easing, but the labor market remains robust. The declining trend in wage growth appears to be aligning with the Fed’s peak terminal rate, supporting the case for a halt in further interest rate hikes. Market projections now indicate a 60% likelihood of the Fed keeping rates steady at the upcoming July meeting, a shift from the previous 40% prediction prior to the earnings report. This potential extended pause may renew investor appetite for risks, particularly within industries that are sensitive to interest rate expectations.

Although lower wage growth could potentially curb discretionary spending, the situation is multifaceted. Real wages, adjusted for inflation, may stabilize if inflation in goods and services continues to decrease. Data from the Bureau of Labor Statistics (BLS) emphasizes differences across sectors, with healthcare and government jobs seeing growth in June while typically offering lower hourly wages compared to positions in technology or finance. The rise in low-wage job opportunities may suppress overall wage metrics, while still maintaining low unemployment rates. On the corporate side, profit margins may experience an improvement as input costs, like energy and raw materials, have declined faster than wages. This scenario could benefit sectors like industrials and consumer staples that rely on stable pricing power. Conversely, businesses with high fixed expenditure, such as airlines or utilities, may face margin pressure if energy costs rise again.

In the equity market, the impact is clear: sectors linked to rate forecasts and sensitivity to inflation are expected to shine. Real estate properties and utilities may benefit from reduced risks of rate hikes, favoring high-dividend REITs and utility companies. Consumer discretionary sectors may see support from stable employment and moderate wage growth, while technology and growth stocks could thrive from a halt in rate increases. Conversely, sectors like energy and materials, which are tied to cyclical demand, may struggle if economic growth falters.

In terms of investment strategies, a focus on rate-sensitive assets while treading cautiously in inflation-exposed sectors is recommended. Overweight positions in utilities, REITs, and tech ETFs are advised, while underweighting energy, industrials, and materials sectors is recommended. Hedging using inverse bond ETFs is suggested in case of unexpected rise in yields.

Moving forward, the wage data released in June suggests a cooling labor market rather than a collapse, potentially solidifying the Fed’s pause and driving gains in the equity markets. While risks like geopolitical tensions and China’s economic slowdown persist, the trend of moderating inflation is now evident. Investors are encouraged to shift towards rate-sensitive sectors while staying adaptable to unanticipated data updates. The BLS benchmark revision in September could further enlighten the wage growth narrative, but, for now, the strategy favors preparation and positioning for a possible turnaround led by the Fed.