The U.S. economy is proving far more resilient than expected

As we move through May, one thing is becoming increasingly hard for markets to ignore, the U.S. economy simply is not slowing in the way many had expected earlier this year.

If anything, the latest data points to an economy that is still running with real momentum. The labour market remains one of the clearest examples. Initial jobless claims recently fell to just 189,000, one of the lowest readings seen in years, while continuing claims, which had been trending higher, have now rolled over and started moving lower again. That combination matters. It suggests companies are still reluctant to cut staff, and people who do lose jobs are finding work relatively quickly.

That is also worth noting in the context of the broader AI debate. There has been growing concern that automation and artificial intelligence could begin displacing white-collar workers at scale. At least for now, the hard data is not showing that. If anything, businesses still appear to be hiring, investing, and expanding, with AI spending looking more like a productivity boost than a major labour market threat.

Growth data tells a similar story. U.S. GDP rebounded to an annualised 2.0% in the first quarter, a sharp improvement from the soft 0.5% pace seen in late 2025. Some of that bounce came from government spending normalising after the federal shutdown late last year, but underneath the headline, private sector investment remained healthy. Business spending on equipment, technology, and AI-related infrastructure continued to hold up well, even as housing and other rate-sensitive parts of the economy remained under pressure.

For equities, that backdrop is still supportive. A strong economy tends to support earnings, consumer demand, and corporate confidence, which helps explain why major U.S. indices have stayed near record highs despite geopolitical tensions and a more uncertain policy backdrop.

Inflation remains the Fed's biggest problem

If growth is holding up, inflation remains the issue that refuses to go away.

Core PCE, the Federal Reserve's preferred inflation measure, is still running at 3.2% year-on-year. That is well above the Fed's 2% target, and more importantly, progress has stalled. Inflation actually ticked higher from the prior month, reinforcing the view that the easy disinflation gains may already be behind us.

That leaves the Fed in a difficult position.

At its latest meeting, policymakers left rates unchanged, but what stood out was the level of disagreement inside the committee. There were more dissents than markets are used to seeing, highlighting a growing divide over how restrictive policy really needs to be if inflation stays sticky while growth remains firm.

Markets have responded accordingly. At the start of the year, investors were still expecting a relatively smooth path toward rate cuts. That view has changed dramatically. Fed funds futures now suggest the first fully priced 25-basis-point cut may not come until late 2027.

That is a major repricing, and it reflects a growing acceptance that rates may stay elevated for much longer than equity bulls had hoped.

What this means for stocks and bond yields

For bond markets, the message is straightforward: if inflation remains sticky and the economy stays firm, yields likely remain elevated, and could still move higher.

The U.S. 10-year Treasury yield has already pushed back toward recent highs, while the 2-year yield has also moved higher as traders continue pushing out expectations for Fed easing. Rising oil prices and geopolitical tensions have only added to inflation concerns, reinforcing the higher-for-longer narrative.

For equities, the picture is more mixed.

On one side, strong growth, healthy employment, and continued corporate spending, particularly around AI infrastructure, remain supportive for earnings. Large technology companies are still spending aggressively on cloud infrastructure, data centres, and semiconductors, helping keep the earnings story alive.

But there is another side to this. Higher bond yields eventually create pressure on valuations, especially in parts of the market where investors are paying premium multiples for future growth. Technology and AI-linked names may continue delivering strong operational results, but if real yields keep rising, it becomes harder for valuation multiples to expand further.

That could create a much more selective market.

Financials, industrials, and energy may continue to benefit if growth stays solid and yields remain elevated. More defensive, rate-sensitive sectors such as utilities and real estate may continue to struggle under higher financing costs.

The bigger shift, though, is psychological. Earlier this year, investors were focused on when the Fed would begin cutting. That is no longer the main debate.

Now the real question is whether the economy can stay this strong without reigniting inflation and pushing yields even higher.

For now, the data suggests the U.S. economy still has momentum. But it also suggests markets may need to adjust to a world where the Fed is no longer the safety net investors had been counting on. If labour data stays firm and inflation remains sticky, both Treasury yields and equity volatility could still have further room to rise before this year is out.