Stronger-than-expected US employment data for May has fundamentally altered the economic outlook, shifting market expectations from interest rate cuts to potential hikes. This pivot threatens the massive valuations of the AI sector, specifically as Elon Musk’s SpaceX approaches a landmark IPO valued at up to $1.8 trillion.
Why did the May jobs report trigger a massive market sell-off?
The US economy added 172,000 jobs in May, a figure that significantly exceeded market expectations. While robust employment is usually seen as a positive, it created a “good news is bad news” scenario for investors. The strength of the labor market suggested that the Federal Reserve might not need to cut interest rates as soon as previously anticipated.
The reaction in the equities market was immediate and punishing. The S&P 500 dropped 2.64 per cent, while the tech-heavy Nasdaq index slid 4.8 per cent. Perhaps most strikingly, the Philadelphia Semiconductor Index—which had climbed roughly 90 per cent this year due to the artificial intelligence boom—plunged by more than 10 per cent.
Bond markets reacted with similar volatility. According to recent data, the yield on two-year Treasury notes jumped from 4.05 to 4.15 per cent, and the 10-year bond yield rose from 4.48 to 4.53 per cent. These movements reflect a growing realization that the interest rate cuts markets were banking on may be delayed or even replaced by rate hikes later this year.
Can the Federal Reserve balance inflation and employment?
The Federal Reserve operates under a dual mandate: maintaining price stability by controlling inflation and maximizing employment. With the job market currently performing strongly, the Fed’s focus is shifting heavily toward inflation, which sits at 3.8 per cent—well above the 2 per cent target.
Inflationary pressures have been driven by two main factors: initial tariffs implemented by Donald Trump and, more recently, the ongoing war in Iran. This environment leaves the new Fed Chair, Kevin Warsh, in a difficult position. While the markets were recently pricing in a 25 basis point cut, futures markets are now pricing in a 25 basis point increase.
The political pressure on Kevin Warsh
The political landscape is adding another layer of complexity. Donald Trump has been vocal in his opposition to higher rates, arguing that the US should not be “penalised” by them. At a recent weekend statement, Trump said, “We built this country by doing great and having rates low… What they do when they raise interest rates, they try and kill success. I don’t want to kill success. We should actually lower rates.”
However, Warsh faces a significant internal challenge. If he advocates for rate cuts in the face of rising inflation and strong employment, he risks a revolt from his colleagues on the Open Market Committee (FOMC). The committee may instead choose to remove the current “easing” bias to signal that the next move could be upward.
Will rising rates threaten the AI and SpaceX valuation boom?
The threat of higher interest rates extends far beyond the bond market; it strikes at the heart of the current AI investment cycle. High-growth companies like SpaceX, Anthropic, and OpenAI rely on massive future cash flows. When interest rates rise, the “discount rate” applied to those future earnings increases, which lowers the current net present value of the companies.
SpaceX is currently preparing for an IPO with a valuation between $US1.75 trillion and $US1.8 trillion. The company is seeking to raise between $US75 billion and $US80 billion in new equity. For a company that is currently wracking up massive losses and trading at 100 times revenue, the cost of capital and interest rate expectations are critical to its success.
The hurdle for index inclusion
While some index providers have changed their rules to fast-track the inclusion of AI-related listings, SpaceX may face a slower path. The S&P Dow Jones index committee maintains strict criteria for IPO inclusion, including:
- The company must be traded on exchanges for at least 12 months.
- It must have a “free float” of at least 10 per cent of outstanding shares.
- It must have reported four consecutive quarters of positive net income from ongoing operations.
Because SpaceX and other AI start-ups are often pre-profit, meeting these requirements could take a significant amount of time. This delay may reduce the “forced buying” typically seen when major index funds like Vanguard add a new stock to their portfolios.
Frequently Asked Questions
Why does strong employment data cause stock prices to fall?
Strong employment data suggests the economy is running hot, which can lead to higher inflation. To combat inflation, the Federal Reserve may raise interest rates, which makes borrowing more expensive and reduces the present value of future corporate earnings.
What is the current inflation target for the Federal Reserve?
The Federal Reserve aims for a long-term inflation rate of 2 per cent.
How does the “discount rate” affect AI companies?
AI companies often have valuations based on profits expected far in the future. When interest rates rise, the discount rate used to calculate the value of those future profits also rises, which lowers the company’s current valuation.
What do you think? Will the Fed prioritize fighting inflation or supporting economic growth? Let us know your thoughts in the comments below or subscribe to our newsletter for more deep dives into the global economy.
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