Bond markets complicate Fed moves after explosive jobs report

Bond yields rose after new employment data showed that the US economy added a staggering 528,000 jobs in the month of July.

Emily Rowland, associate chief investment strategist at John Hancock Investment Management, told Yahoo Finance that the strong July jobs report shows the economy is “not quite there yet” when it comes to a recession.

Michael Pierce, chief US economist at Capital Economics, was firmer in an email after Friday’s data: “An unexpected acceleration in non-farm payroll growth in July, combined with a further decline in the unemployment rate and a renewed recovery in wage pressure, and mocking claims that the economy is on the brink of recession.”

But bond markets remain concerned. This concern is reflected in how yields will move after Friday’s data.

After Friday’s jobs report, the yield curve became even more inverted, with 2-year bond yields jumping 21 basis points to 3.24% and 10-year yields (^TNX) up 16 basis points to 2.84%.

Long-term bonds usually yield no less than short-term bonds, as investors demand more compensation for lending longer to the US government (or any borrower for that matter).

So investors are keeping a close eye on these “reversals” in the 2-year/10-year spread as they predate each of the last six recessions in the US. That yield curve inverted in 2019, before the pandemic, and flashed again in April of this year.

The spread between the 2-year and 10-year Treasury yields became more deeply reflective after Friday’s jobs report. (Source: Fred)

And while Rowland said the July jobs data doesn’t reflect the recession for now, the fact that the curve reversed further on Friday illustrates the market’s deep expectations for one.

Roland said, “There are more things that need to happen before the full recession begins. But [we’re] There is likely to be a deeply inverted yield curve.”

The question is what the Fed’s next step is, especially as high inflation continues to pressure policy makers to increase borrowing costs in an effort to cool economic activity. The central bank moved in both June and July to raise interest rates by 0.75%, the largest moves made in a single meeting since 1994.

The Fed hopes it can moderate economic growth without raising rates so high that companies start laying off workers. July’s hot jobs report supports the Fed’s argument to leave the healthy job market as is, but larger-than-expected wage gains may cause employers to continue to pass on higher costs to consumers.

A rental sign hangs on the door of GameStop in New York City, US, April 29, 2022. REUTERS/Shannon Stapleton

A rental sign hangs on the door of GameStop in New York City, US, April 29, 2022. REUTERS/Shannon Stapleton

Average hourly wages rose 5.2% year-on-year in July, showing no slowdown in wage growth compared to previous months.

“Obviously a slower pace of wage growth would be in addition to the target of lowering persistently high inflation, but today’s report likely won’t bring relief to the Fed on this front,” BlackRock’s Rick Reader wrote on Friday.

Markets are now pricing in the prospects of a more aggressive move in interest rates at the upcoming Federal Reserve meeting, which is scheduled to conclude on September 21. Fed fund futures now set a 70% probability of a 0.75% move in September, a notable change from the 0.50% markets were moving ahead of Friday’s jobs report.

Repricing expectations for interest rate movements from the Fed is also behind the action in the bond markets, since short-term Treasuries (such as the US 2-year) tend to follow the Fed’s policies on the Fed money rate more closely.

“The yield curve has reversed, and now it’s really inverted,” Rowland said. “And we know that this is a classic harbinger of recession.”

Brian Cheung is a reporter covering the Federal Reserve, the economy and banking at Yahoo Finance. You can follow him on Twitter Tweet embed.

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