US unit labour costs rose at a 2.3% annual rate in the first quarter. This was down from 4.4% in the previous quarter.
Unit labour costs measure the cost of labour needed to produce one unit of output. The change suggests slower growth in labour cost pressure compared with the prior period.
Unit Labour Costs Signal Cooling Inflation
The drop in unit labor costs to 2.3% is a powerful disinflationary signal that we cannot ignore. This sharp decline from the 4.4% rate we saw at the end of last year suggests wage pressures are not translating into the sticky inflation the Federal Reserve feared. This gives the Fed more flexibility and weakens the case for any further rate hikes.
We are now looking at the Fed’s upcoming June meeting through a more dovish lens. Before this data, federal funds futures were pricing in only a 35% chance of a rate cut by September; we expect that to climb above 50% in the coming days. This marks a significant shift from the hawkish rhetoric that dominated the second half of 2025.
Our immediate focus is on interest rate derivatives, specifically options on Treasury futures. The 2-year Treasury note, highly sensitive to Fed policy, is the primary target for long positions as yields are likely to fall further. We see the 10-year yield, which has already dipped to 3.75% this morning, continuing this downward trend toward the 3.5% level.
This environment is very bullish for equity indices, so we are positioning through call options on the S&P 500 and the rate-sensitive Nasdaq 100. Lower labor costs directly boost corporate profit margins, which according to recent data from FactSet have been squeezed over the past two quarters. Looking back at 2019, a similar period of moderating labor costs preceded a strong rally in stocks driven by margin expansion.
We also see an opportunity to sell volatility, as this report removes a key piece of uncertainty from the market. The VIX index has been elevated around 17, and we anticipate it will drift lower toward the 14 level as the Fed’s path becomes more predictable. Strategies like selling VIX call spreads should perform well in the coming weeks.
