Friday’s official U.S. jobs report for August gave traders and Federal Reserve policy makers just about everything they could have hoped for — reducing the market-implied likelihood of further 2023 rate hikes and producing a less deeply-negative Treasury curve.
Though the headline number of job gains came in at a higher-than-expected 187,000, the report contained enough offsetting factors to support the case that the labor market is slowing by just enough to avoid tipping the economy into a contraction. Unemployment rose to 3.8% as labor-force participation picked up, growth in hourly wages was modest, and job gains in July and June were 110,000 lower than previously reported.
Read: ‘Music to the Fed’s ears’ — analysts react to jobs report
Financial markets initially reacted to the data with a rally in short-dated Treasurys that sent the policy-sensitive 2-year yield lower on the view that the Fed might be done with hiking rates. As the morning wore on though, Cleveland Fed President Loretta Mester threw a kink into the market’s thinking by saying inflation remains too high. Nonetheless, the Treasury yield curve continued to go less deeply negative on Friday, as investors stayed hopeful that the U.S. faces diminishing chances of an economic downturn.
“The combination of slower job growth, a rising labor-force participation rate, and weaker earnings growth makes this a near perfect report from the Federal Reserve’s perspective,” said David Donabedian, chief investment officer of Atlanta-based CIBC Private Wealth US, which oversees $100.7 billion in assets.
Donabedian’s colleague, Gary Pzegeo, the firm’s Boston-based head of fixed income, added that “normalizing conditions in the labor market makes the Fed’s job easier and reduces the odds of another tightening this year,” and “the Treasury yield curve is steepening in response to the data, suggesting that the bond market expects the Fed is done.”
As of Friday morning, the policy-sensitive 2-year yield BX:TMUBMUSD02Y was up slightly at 4.887%, while the 10-year yield BX:TMUBMUSD10Y jumped 10.5 basis points to 4.195%. U.S. stocks DJIA SPX COMP turned mostly lower, though.
The 10-year yield currently sits well below the 2-year yield as a result of the Fed’s inflation battle and campaign of interest rate hikes since March 2022, which has pushed the fed funds rate target to 5.25%-5.5%. That left the spread between the two yields at around minus 69 basis points on Friday.
The 2s/10s spread is widely watched because it has historically been one of the Treasury market’s most reliable indicators of impending recessions. It slopes upward, not downward, when there’s greater optimism about the economic outlook. Right now, the spread is slowly clawing back some of this year’s earlier pessimism, which had pushed it into triple-digit negative territory. And theoretically, the yield curve should continue to disinvert if investors factor in a possible shift in Fed policy.
Fed funds futures traders priced in a 93% chance of no action by the Fed in September, and a 60% or greater chance of the same for November and December, according to the CME FedWatch Tool.
Friday’s data “is decidedly positive,” said Quincy Krosby, chief global strategist for LPL Financial in Charlotte, N.C. “However, when all is said and done, it will be the trajectory of inflation that will ultimately form the Fed’s rate decision— inflation remains sticky.”
At TradeStation, the Florida-based parent of online brokerage services firms, David Russell, global head of market strategy, said “the big takeaway from today’s number is that people are back in the labor force and looking for jobs.”
“Coronavirus distortions continue to fade,” Russell wrote in an email. “That’s visible from the jump in unemployment and participation. Other items like hourly wages and negative revisions show softening and argue for a Fed to pause.”
