What’s next for the bond market is all about non-farm payrolls. The Friday jobs report is expected to show 200,000 jobs created but if there’s a disappointing reading, the market will read that as a sign that the Fed hiking cycle is over.
Moreover, talk about a recession will return and there will be a demand for the safety of bonds.
Technically, Treasury yields are at an inflection point. US 10s are up 10 bps today to 4.18% and that’s perilously close to the October 2022 closing high of 4.23% and the intraday high of 4.338%.
US 10-year yields
Those previous highs came with US inflation at 9% and now it’s back to 3%. But what’s also important to keep in mind is that when those previous highs were hit, the Fed funds rate was much lower and that assumption was that +5% Fed funds would lead to a recession. Well, we’re at 5% and the economy is humming along.
So the thinking is that even though inflation is falling, the easy comps are in the past and the Fed may struggle to get inflation all the way back to 2% without hiking even further. Moveover, the lack of a recession means rates will have to stay higher for longer, so compensation for holding long-duration needs to rise.
Bill Ackman made that case today:
I have been surprised how low US long-term rates have remained in light of structural changes that are likely to lead to higher levels of long-term inflation including de-globalization, higher defense costs, the energy transition, growing entitlements, and the greater bargaining power of workers. As a result, I would be very surprised if we don’t find ourselves in a world with persistent ~3% inflation
There are plenty of arguments on the other side as well, including deflationary impacts of AI, automation and demographics.
Fixed income strategists at BMO believe it’s time to buy bonds, not sell them:
We maintain that over the medium term, the current backup will have been an attractive opportunity to add duration exposure, however in an acknowledgement of the event risk posed by the balance of this week’s fundamental updates, we won’t advocate catching the falling bond just yet.
They note the importance of the jobs report and with today’s employment component of the ISM services index falling, there’s some scope for disappointment. BMO also argues that risks are one-way with strong jobs not likely to lead to further pricing in of hikes, while a soft employment landscape would quickly lead to the pricing in of cuts:
As it relates to the forward path of policy, a low unemployment rate alone will not be enough to inspire even more tightening from the FOMC. For that, the trend of disinflation would need to begin to reverse and we expect an acceleration in consumer price growth would be needed to justify another adjustment to terminal forecasts. What a still-robust hiring landscape will do is keep the Fed from cutting for longer given that even in the most optimistic scenario, core inflation will not have returned to 2% at any point in the near term. As long as the unemployment rate stays low, there is little incentive for the Fed to make policy less restrictive – said differently, inflation will drive more hikes, but employment will be what triggers rate cuts.
After Friday’s non-farm payrolls report, the focus will quickly shift to next week’s CPI data. The current consensus is a relatively-benign +0.2% m/m reading on both the headline and the core.