Record Highs on Mixed Signals: The Macro Strategy for Sustaining the Rally

The major US indices are trading at historic levels, but the rally is built on a fragile foundation. The S&P 500 has posted a new all-time high, the Nasdaq 100 has hit a 3.5-week peak, and the Dow Jones Industrial Average has closed above 49,000 for the first time. This record-setting momentum is being driven by a potent mix of geopolitical events and the enduring AI narrative, yet it is being propped up by a key dovish signal from the labor market.

The immediate catalyst has been a series of economic reports that point to softening demand. The December ADP employment report showed private payrolls grew by just +41,000, falling short of expectations. More critically, the November JOLTS report revealed a sharp drop in job openings to a 14-month low of 7.146 million. This dovish data has knocked bond yields lower and supported stocks, as it reinforces the view that the Federal Reserve will keep interest rates on hold. The market is essentially betting that persistent weakness in labor demand will force a pause in monetary tightening.

Yet this is where the central tension emerges. The rally is being sustained by evidence of underlying labor market weakness, even as the broader economic picture shows pockets of strength. For instance, the December ISM services index unexpectedly rose to a fourteen-month high, and copper prices have surged on trade concerns. This divergence sets up the critical question for the coming weeks: can the rally be sustained on the back of a softening labor market, or will the ebbing demand for labor eventually translate into broader economic slowdown that the market has yet to price in? The upcoming December nonfarm payrolls report will be the next major test of this fragile setup.

The Dovish Policy Pivot: Fed and ECB

The market's record highs are being bankrolled by a decisive shift in monetary policy expectations. The pivot from a hawkish stance to a dovish one is now the central pillar of the rally, with bond yields falling sharply and equity valuations receiving a direct boost. This change is not theoretical; it is being priced into the market with remarkable clarity.

The catalyst was a series of economic reports signaling a softening labor market. The most critical data point was the November JOLTS report, which showed job openings plummeting to a 14-month low of 7.146 million. This dovish signal has directly influenced the market's view on the Federal Reserve. Economists now expect the Fed to keep interest rates unchanged later this month, and the market is pricing in a high probability of no rate hike at the upcoming ECB meeting, with a mere 1% chance of a 25-basis-point increase.

The impact of this dovish pivot is immediate and material. It has driven Treasury yields lower, providing a crucial tailwind for stocks. The 10-year T-note yield has fallen to 4.15%. This decline in bond yields lowers the opportunity cost of holding equities and supports higher valuations, effectively financing the rally. The same dynamic is playing out in Europe, where easing inflation concerns have also sent yields lower.

Viewed another way, the policy shift is a direct response to the labor market data. The JOLTS report's sharp drop in job openings points to ebbing demand for labor, a condition that historically pressures central banks to pause or cut rates. The market is betting that this weakness will force a dovish policy response, and it is acting accordingly. The setup is clear: a softening labor market is driving a dovish policy pivot, which is lowering bond yields and supporting equity prices. The sustainability of the rally now hinges on whether this dovish policy stance can be maintained as the economy navigates its current divergence.

Sectoral Winners and Losers: AI Narrative vs. Real Economy

The macro backdrop is creating a stark divergence in sector performance, with the AI narrative powering a narrow rally while broader economic indicators point to underlying strain. The tech-heavy Nasdaq 100 has been the primary engine of the record highs, driven by a relentless focus on artificial intelligence. This week, the narrative was set at CES in Las Vegas, where Nvidia and AMD unveiled competing AI roadmaps, with CEO Jensen Huang launching Nvidia's next-generation Vera Rubin platform. The market's reaction was immediate, with notable gainers in the tech space on Tuesday including Amazon, Micron, and Broadcom. This AI-driven momentum has allowed the Nasdaq to climb 0.6% to a fresh peak, even as other indices showed more mixed results.

Contrast this with the performance of industrials and materials, sectors more directly tied to the real economy. Here, the pressure is clear. Chip makers and data storage companies are under pressure today after their sharp rally on Tuesday, with Western Digital down more than 7% to lead the Nasdaq 100's losers. This weakness reflects a tangible concern over demand and trade policy, suggesting that the AI boom is not yet translating into broad-based industrial strength. The divergence is even more pronounced when viewed through the lens of commodities. While equities rally, copper (HG=F) continued to surge after breaking above $13,000 a ton for the first time, driven by worries over potential Trump tariffs and resulting supply tightness. This decoupling is telling: a commodity sensitive to global growth and manufacturing is soaring on supply fears, while the equity market is being buoyed by a narrative of technological disruption.

The bottom line is a market that is increasingly bifurcated. The rally is being financed by a dovish policy pivot and concentrated AI optimism, allowing the Nasdaq to set records. Yet, the real economy is showing signs of stress, from a slowest pace of expansion in eight months in the US services sector to the sharp sell-off in data storage stocks. This creates a vulnerability. If the AI narrative ever falters or if the underlying economic weakness in industrials and materials begins to feed back into corporate earnings, the narrow base of the rally could quickly come under pressure. For now, the market is trading on two separate stories.

Catalysts and Risks: The Path to 2026

The path to sustaining the record highs now hinges on a few critical tests. The immediate and most important catalyst is the upcoming December nonfarm payrolls report. Economists project a 4.5% unemployment rate, which will provide the final clarity on whether the labor market's recent softness is a temporary blip or the start of a more profound deterioration. The ADP preview for December showed a reversal from November's losses, with companies adding 41,000 hires, but the figure came in below consensus. This data will be the definitive check on the "no hire, no fire" state that has defined the market's dovish bet. If the official report shows a significant slowdown in hiring, it will validate the soft landing thesis and likely reinforce the policy pivot. A stronger-than-expected print, however, could force a reassessment of the entire setup.

Geopolitical risks remain a persistent undercurrent. The flow of Venezuelan oil is a prime example. President Trump's announcement that interim authorities would turn over between 30 and 50 million barrels of sanctioned crude to the U.S. has already pressured oil prices. While the market initially shrugged off the weekend military action, the potential for a sustained supply increase introduces volatility. This could pressure oil-sensitive sectors and complicate the inflation outlook, a key variable for central banks. As one strategist noted, the real test is whether this event leads to "social calm" or a new round of instability that rattles markets.

The primary risk to the rally, however, is a breakdown in the soft landing narrative. The market is currently pricing in an extraordinary degree of policy patience. The 10-year Treasury yield has fallen to under 4.15%, and the market is assigning a mere 1% chance of an ECB rate hike. This pricing assumes that labor market weakness will persist just enough to keep inflation subdued but not so much as to trigger a recession. If the December jobs report shows a sharp deterioration in labor demand, it could force a reassessment of the dovish pivot itself. A policy shift from "hold" to "cut" would be a positive for bonds and tech, but it would also signal deeper economic concerns that could eventually feed back into corporate earnings and broader equity valuations.

The bottom line is that the rally is now on a knife's edge. It is being sustained by a dovish policy pivot driven by labor market data, but that same data is the most likely source of a reversal. The upcoming jobs report is the next major test of this fragile equilibrium. For now, the market's calm is a function of its own expectations. Any shock to those expectations-whether from labor data or geopolitical developments-could quickly change the trajectory.