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What a day! A blowout US jobs report is wrecking long-dated Treasuries.
The US created 336,000 jobs in September, while economists were predicting a ~162,000 print. Find more detail on the report in mainFT’s coverage here.
Most notably for our purposes, the benchmark 10-year Treasury has, uh . . . responded. Yields are very up and prices are very down. From FactSet:
Ouch. There are lots of round numbers and “highest in 15 years” records in today’s headlines. The 30-year yield hit 5 per cent, the 10-year rose more than 10bp to 4.8 per cent, and long-term Treasuries are yielding more than they have since 2007.
The obvious explanation for this is that a stronger-than-expected labour market should lead to more consumption and stronger inflation, all else equal.
A few caveats: oil prices, a crucial input into inflation, are only up 0.5 per cent Friday. Wages weren’t up much, climbing 0.2 per cent for the month. And the jobs market is well known to be a lagging indicator of economic growth, not leading.
But sure, whatever, the Fed does seem to be waiting for data to respond before making policy decisions, so “short-term rates will stay higher for longer” is probably one implication of today’s jobs report. And futures markets are indeed pushing out the Fed’s next rate cut into the second half of 2024.
Click here to embiggen.
Predicting the future is tricky, though. And once we go beyond two- and three-year maturities, Fed policy stops mattering so much. There’s no real reason that higher policy rates in 2024 would cause the 30-year yield to jump. For Treasuries maturing in 10 years and beyond, we need to consider inflation compensation and term premia in our interpretation of price moves.
Luckily, Dario Perkins from TS Lombard has looked at a few historical examples of market moves like this, and laid out a few different options of what can happen next.
Our readers will know that an inverted yield curve — which the US has had for roughly a year — is a sign that recession is on its way. But in the past, it has been a year or longer after the curve first inverts before a downturn hits. That leaves timing a little . . . tough.
So strategists like to use a slightly different tool for timing: the uninversion of the yield curve tends to be a sign that recession is really imminent. This makes intuitive sense; when the economy is clearly about to contract, markets start pricing in a steep path of rate cuts, betting the Fed will address the slowdown by easing policy.
Today’s yield curve is much less inverted than it was months ago, though it’s not fully uninverted yet, with most short-dated yields still above long-dated yields.
So how to interpret that? Perkins has a nice rundown of the history of “bear steepeners”. That’s when the gap between short- and long-term yields narrow because of a sell-off, not a rally in short-dated bonds (which usually happens in anticipation of rate cuts).
Here’s what Perkins found:
The table shows the historic record from bear steepening is pretty mixed.
Recessionistas will point to 2006, where the Fed dragged yields out of inversion and the financial system collapsed.
Inflation hawks will point to the early 80s, where the Fed fell behind the curve.
The bullish scenario is a repeat of the 1968 soft landing.
So whatever your priors, the evidence supports them!
Great! One thing today’s move does signal is higher costs for new mortgages. The average rate on new 30-year fixed-rate mortgages has already climbed to 7.5 per cent from 3.1 per cent at the end of 2021. All of these higher rates have not been great for sentiment in the housing market, Perkins writes:
Beyond that, it’s difficult to say.
The long-end sell-off does seem to reflect some growing belief in a structural shift in the US economy that is raising r*, or the “neutral” rate of interest at which inflation and growth will be steady. In other words, investors seem to think US economic growth can persist even with relatively high short-term rates.
The problem is, as Perkins’ historical analysis shows, is that investors aren’t always correct in that belief. And in 2006, they decided everything was actually great right before a massive downturn.
Further spending
— You can buy your own R-Star War t-shirt here
Source: Economy - ft.com
