With the nonfarm payrolls report due on Friday, the AI rally has already driven U.S. equities to nine consecutive gains. Bank of America expects the May nonfarm payrolls data to beat expectations for the third straight month, though the unemployment rate and wage growth have not yet reached levels that would trigger a rate hike. Even if the data comes in strong, the most likely outcome remains 'higher rates for longer' rather than 'restarting a hiking cycle.' However, the bond market has already sounded an 'interest rate hike alarm,' with short positions becoming crowded.
The AI-driven rally in U.S. equities continues to gain momentum, while the bond market has already begun to shift direction. Ahead of Friday’s release of the U.S. May nonfarm payrolls report, the market is exhibiting a clear divergence: on one side, U.S. stocks are sustaining their euphoric rally fueled by AI-related capital spending; on the other, bond shorts are increasingly betting on rising inflation and interest rates.
Although Bank of America expects the U.S. labor market to remain robust, it does not view it as strong enough to compel the Federal Reserve to hike rates. The bank forecasts that May nonfarm payroll growth will reach 95,000 (above market expectations), with the unemployment rate holding steady at 4.3%. Such data would be sufficient to support the Fed’s current stance of remaining on hold, and a renewed rate hike still appears distant unless unemployment falls further toward 4.0%.
However, bond traders are clearly more cautious. According to Bloomberg, although the yield on the 10-year U.S. Treasury has retreated from its recent high near 4.69% two weeks ago to below 4.5%, short positions in Treasuries remain crowded, and market bets on a rate hike later this year continue to accumulate.
Meanwhile, the AI investment frenzy continues to sweep through the stock market. Bolstered by large-scale financing activities in the tech sector, U.S. equities extended their rally for a ninth consecutive trading session as of Tuesday's close,$S&P 500 Index (.SPX.US)$surpassing the 7,600 mark. According to a prior article by Wall Street Journal, data from Goldman Sachs’ trading desk shows that AI-related assets have once again become the market’s main driver: the AI-themed long-short portfolio rose by 650 basis points in a single day, the data center segment gained 470 basis points, and the AI semiconductor sector climbed 320 basis points.
This equity-bond divergence reflects the core tension currently facing markets: the wave of AI infrastructure investment continues to boost corporate earnings and risk appetite, while resilient employment and potential inflationary pressures keep bond investors highly vigilant about the interest rate outlook. Optimism versus caution, growth versus inflation—these two narratives are unfolding simultaneously within the same market.
Bank of America Forecast: Robust Employment, but Not Enough to Trigger Rate Hikes
In a report released on June 2, Bank of America economist Shruti Mishra projected that May nonfarm payrolls would increase by 95,000 (with private-sector payrolls rising by 100,000), exceeding the market consensus and significantly surpassing the estimated “break-even” threshold of approximately 20,000 jobs.
By sector, education and healthcare are expected to continue leading employment gains. These sectors have relatively low AI penetration and benefit from supportive demographic trends. Additionally, manufacturing PMI has remained in expansionary territory for five consecutive months, likely supporting a recovery in trade and transportation employment. Leisure/hospitality and construction are also expected to post gains for the third straight month, with construction further supported by sustained demand from data center development.
Upside risks should not be overlooked—employment data could still surprise on the high side. Despite an increase in white-collar layoffs, initial jobless claims remained low in early May, indicating no significant softening in the overall labor market. ADP’s weekly data has notably rebounded since late March. Moreover, early hiring related to the World Cup could provide additional support to the leisure and hospitality sector.
On wages, Bank of America expects average hourly earnings to rise by 0.3% month-over-month, with average weekly hours remaining unchanged at 34.3. The bank believes current income growth is sufficient to support consumer spending but has not yet posed significant inflationary pressure.
Bond market bears remain firmly positioned, with rate hike expectations continuing to be priced in.
Although Bank of America maintains a cautious stance on rate hikes, the bond market’s actual positioning has been more aggressive. According to Bloomberg, strategists at Bank of America noted in another recent weekly report that 'positions remain persistently skewed toward short exposure,' and despite somewhat diminished momentum compared to earlier, this dynamic will continue to reinforce an upward bias in rates.
In the options market, traders hedged against both upside and downside scenarios over the past week. Notable positions include a $16 million options trade betting that the 10-year yield will fall back to 4.4% by the end of June, and another wagering that the 10-year yield will breach 5% within several months—a level not seen since its brief touch in October 2023.
In the SOFR options market, the 96.50 strike remains the most concentrated position across June, September, and December contracts, with recent inflows continuing to build exposure via call spreads. Put premiums on 30-year Treasury options also remain significantly higher than call premiums, and this gap widened further over the past week, reflecting strong market demand for protection against rising long-end rates.
According to JPMorgan’s Treasury client survey, investors shifted from a modest net long position back to neutral during the week ending June 1, reducing long positions by 2 percentage points while short positions remained largely unchanged.
Nonfarm payrolls emerge as a pivotal variable, with risks tilted in both directions.
Friday’s nonfarm payroll data will serve as a critical test of current market pricing. According to Bloomberg, stronger-than-expected data would reinforce the rationale behind existing short positions and push yields higher, whereas weaker-than-expected figures could trigger short-covering and provide fuel for a bond market rally.
Bank of America also highlights downside revision risks: data from the Quarterly Census of Employment and Wages (QCEW) suggests that recent robust nonfarm payroll readings may be overstated and subject to downward revisions. Additionally, the divergence between household survey and establishment survey employment data has persisted for several months, with the former declining for four consecutive months—contradicting the trend shown in nonfarm payroll data—and this discrepancy warrants continued monitoring.
Bank of America maintains its view on Federal Reserve policy: with the unemployment rate at or below 4.3% and upside inflation risks present, the Fed is likely to hold rates steady in the near term; an actual rate hike would require the unemployment rate to approach 4.0%. The bank expects the unemployment rate to gradually decline to 4.2% by 2027.
AI Boom Meets Bond Market Warning: A Clash of Two Narratives
The market is currently exhibiting a rare divergence in sentiment: U.S. equities continue to rise, driven by AI-related themes, with strong appetite for risk assets; meanwhile, the bond market remains under persistent bearish pressure amid dual headwinds from inflation and resilient employment data.
According to a Bank of America report, the education and healthcare sectors have consistently led job growth, partly because their relatively low AI adoption rates—this indirectly confirms that AI’s displacement effect on employment in certain sectors is already underway, though it has not yet been fully reflected in aggregate data.
For investors, Friday’s nonfarm payrolls data will serve not only as a near-term catalyst for bond market direction but also as a critical test of whether the 'AI-driven boom' can coexist with upward pressure on interest rates. If employment data remain robust, market pricing of further Federal Reserve rate hikes could intensify, inevitably bringing to the fore the pressure facing highly valued tech and AI-related stocks.
Editor/Rocky