Markets Broaden as Labor Data Stabilize and Fed Uncertainty Re-emerges

January 12, 2026

Financial Markets

U.S. equity markets finished higher in the first whole week of 2026 trading, with leadership shifting toward more cyclical and defensive areas. The equal-weighted S&P 500 and small-cap S&P 600 outperformed, while pockets of mega-cap technology faced modest pressure. Small- and mid-cap equity indexes reached record highs during the week, underscoring improving breadth and reducing the market’s reliance on a narrow group of large-cap growth leaders. Historically, this broadening has been a constructive signal, suggesting a healthier and more durable advance.

U.S. equity markets opened the week in risk-off mode after reports that the Department of Justice issued subpoenas as part of a criminal investigation involving Federal Reserve Chair Jerome Powell. The news delivered an unexpected political shock to markets, reviving concerns about central bank independence and increasing perceived policy risk. While details remain limited, any legal or political pressure on Federal Reserve leadership could heighten market volatility and complicate the outlook for monetary policy. We have more to say on this topic toward the end of today’s letter.

Economics

It was an exceptionally busy week for labor market data, but taken together, the releases did little to change the prevailing narrative. The labor market continues to cool gradually rather than deteriorate sharply, reinforcing the well-established “low hiring, low firing” dynamic.

Private payroll growth remained modest. December ADP employment rose by 41,000, slightly below expectations, with hiring concentrated at medium-sized firms. Small-business employment stabilized after recent declines, though pressures remain elevated amid higher borrowing costs and a record number of small-business bankruptcies last year.

The November JOLTS report reinforced the cooling trend. Job openings declined to 7.14 million, the lowest level since September 2024, while both the openings rate and hiring rate moved lower. Layoffs remained subdued, and the quit rate edged up slightly, suggesting workers retain some confidence even as labor demand eases.

Weekly claims data told a similar story. Initial jobless claims remained well contained, and the four-week moving average fell to its lowest level since April 2024. At the same time, continuing claims rose to roughly 1.9 million, among the highest readings since late November, suggesting somewhat longer job searches for those who lose work. Challenger job cuts declined sharply in December, though total layoffs for 2025 were the highest since the global financial crisis.

The government’s December employment report rounded out the labor market data for the week. Nonfarm payrolls increased by 50,000, slightly below consensus expectations, with downward revisions to prior months. The unemployment rate, however, edged lower to 4.4%, and labor force participation was stable. Wage growth remained firm, with average hourly earnings rising 0.3% during the month and accelerating to a 3.8% year-over-year pace. Overall, the report suggested tentative stabilization in labor conditions, leading markets to scale back expectations for near-term rate cuts.

Beyond the labor market, the “two-speed” nature of the economy remained evident. Manufacturing activity stayed in contraction territory, marking a tenth consecutive month below 50, while services activity strengthened meaningfully. The ISM Services index rose to its highest level since October 2024, with new orders and employment both expanding. Pricing pressures in services eased modestly, though some firms continued to cite elevated costs tied to tariffs, trade uncertainty, and labor shortages.

Encouragingly, third-quarter productivity surged 4.9%, the strongest gain in five years, while unit labor costs declined unexpectedly—a favorable combination for growth and disinflation. Consumer sentiment also improved modestly in early January, reaching its highest level since September, though it remained the tenth-lowest reading since the inception in 1952. The recent lift was driven by improving confidence among lower-income households. Together, productivity gains and stabilizing sentiment provide a constructive offset to an otherwise cooling growth backdrop.

Policy & Geopolitical Developments

As pressure from the upcoming midterm elections builds, populist policy proposals are expanding, driving geopolitical and fiscal headlines back to the forefront and contributing to crosscurrents beneath the surface. President Trump’s call for a sharply higher military budget, developments surrounding Venezuela’s oil exports, and ongoing negotiations involving Ukraine all captured investor attention. While Venezuela-related tensions appeared to ease, energy markets ultimately took a measured view given ample global supply. Other geopolitical flashpoints—ranging from Iran to Russia and ongoing U.S.-China frictions—remain sources of tail risk. As has often been the case, markets have so far demonstrated an ability to absorb geopolitical noise, though the potential for volatility remains. On the domestic front, the administration proposed capping credit card interest rates to 10% and preventing institutional investors from purchasing homes.

Federal Reserve Independence Comes Back into Focus

Over the weekend, an unexpected political development added another layer of uncertainty to the economic outlook. Reports emerged that the U.S. Department of Justice has launched a criminal inquiry into Federal Reserve Chair Jerome Powell, focusing on his June testimony to Congress about the roughly $2.5 billion renovation of the Federal Reserve’s Washington, D.C., headquarters. According to press accounts, the investigation was approved months ago but has only now come to light, marking a clear escalation in tensions between the White House and the Federal Reserve. President Trump has publicly stated that he was unaware of the investigation.

Chair Powell confirmed that the Federal Reserve was served with grand jury subpoenas on Friday and warned that the inquiry could ultimately lead to criminal charges. In a resolute statement and video, Powell characterized the action as an attempt to exert political pressure on the Federal Reserve, arguing that it risks undermining the institution’s ability to set monetary policy based on economic evidence rather than political considerations. The situation has fueled concern that the administration may be seeking either a legal pathway to remove Powell as Chair before his term ends in May or to discourage him from remaining on the Board of Governors, where his term extends through January 2028. President Trump clearly wants control of another Fed seat as soon as possible to facilitate a lower-rate policy.

The broader legal backdrop remains unsettled. The Supreme Court is still considering whether the administration’s prior attempt to remove Fed Governor Lisa Cook was improper, with oral arguments scheduled for January 21^st. At the same time, the inquiry into Powell has prompted bipartisan concern. Senate Banking Committee Chair Thom Tillis (Republican-NC) said he would oppose confirmation of any future Federal Reserve nominees until the matter is resolved, underscoring the potential institutional fallout and raising questions about the perceived independence of both the Federal Reserve and the Justice Department.

Markets are also looking ahead to the risk of leadership transition. President Trump is expected to announce his preferred successor to Powell later this month, and prediction markets now show a narrowing race between White House advisor Kevin Hassett and former Fed Governor Kevin Warsh. While leadership changes at the Fed are not unusual, the context of this transition is highly atypical, heightening uncertainty about the future conduct of monetary policy.

We firmly believe that maintaining the Federal Reserve’s independence is essential to the long-term health and credibility of the U.S. economy and financial markets. While the track record is not perfect, given the economic challenges of COVID, we have consistently supported Chairman Powell’s leadership and stewardship of monetary policy through an unprecedented and volatile period. In our view, the Fed’s ability to operate free from political pressure remains a cornerstone of market confidence.

Conclusion

This week’s market action reinforced a constructive yet selective backdrop. Equities advanced with broader participation, highlighted by strength across the market-cap spectrum, reducing reliance on a narrow set of leaders. From a macro perspective, the data continue to point to moderating growth rather than a sharp slowdown. Manufacturing remains soft, services are holding up better, and productivity trends are encouraging.

At the same time, risks have become more layered. Political unpredictability, elevated geopolitical uncertainty, and the evolving path of interest rates all warrant close monitoring. Recent legal developments involving Federal Reserve leadership add another source of uncertainty, raising questions about central bank independence and the policy environment at a sensitive point in the cycle. In this setting, leadership can shift quickly, and volatility can re-emerge. A calm, diversified approach, grounded in discipline and an appreciation for both opportunity and risk, remains appropriate as the expansion continues to mature.

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