Bond Traders See Jobs Testing Hawkish Fed Pricing: Markets Wrap

This content was published on January 9, 2025 - 18:35

10 minutes

(Bloomberg) — The world’s biggest bond market halted a selloff that rattled trading around the globe, with investors gearing up for jobs data that will help shape the outlook for Federal Reserve rates.

Treasuries saw mild gains across the curve, with 30-year yields dropping from the highest since 2023. The bond market will close at 2 p.m. New York time in observance of a national day of mourning for former President Jimmy Carter. US stock markets are shut. Meantime, the pound dropped to a more than one-year low and gilts sank on concern the Labour government will struggle to keep the deficit in check as borrowing costs surge.

“While it might be tempting to extract some greater directional implications from this divergence, we’re content to point toward the magnitude of the recent selloff in Treasuries as so significant as to warrant a reprieve — even as the gilt market slips further,” said Ian Lyngen and Vail Hartman at BMO Capital Markets.

As for Friday’s jobs data, the strategists bet it will offer a litmus test for the market’s “hawkish Fed pricing.”

“We see an asymmetric balance of risks around the payrolls report in that a miss will likely have a disproportionately larger impact on US rates than a beat of equal magnitude,” they added. “Said differently, the market appears to be biased for a strong report.”

The figures are also seen by many as unlikely to alter the view of Fed officials that they can slow the pace of rate cuts amid a durable economy and inflation that’s dissipating only gradually.

In the run-up to the data, Fed Bank of Philadelphia President Patrick Harker said officials are on track to lower rates this year, but the exact timing will depend on what happens with the economy. His Boston counterpart Susan Collins said a slower approach to adjusting interest rates is merited now as officials confront “considerable uncertainty” over the economic outlook.

The yield on 10-year Treasuries fell one basis point to 4.68%. The dollar edged up mildly.

US employers probably tempered their hiring last month to wrap up a year of moderating yet still-healthy job growth that economists expect to carry on in 2025. Payrolls increased 165,000 in December, when the labor market moved beyond distortions caused by hurricanes and strike activity in previous months, according to the median projection of economists surveyed by Bloomberg.

Meanwhile, the unemployment rate is forecast to hold steady at 4.2% and average hourly earnings growth is seen cooling a touch from a month earlier.

“We expect the Fed would require a clear miss in key dimensions to spur a rate cut this month (payroll growth well below 100,000 and a jobless rate above 4.3%) versus proceeding with the hold that is currently well priced in,” said Andrew Husby at BNP Paribas Securities.

The pace of payroll employment growth in 2023-2024 will likely be revised lower in next month’s report, but should still indicate a resilient job market, he said.

“While losing momentum, we are still projecting a relatively firm increase for job gain,” said Oscar Munoz and Gennadiy Goldberg at TD Securities. “We also look for the unemployment rate to stay unchanged at 4.2%, amid a likely loss of momentum in wage growth owing to favorable seasonal factors.”

They noted that a moderating, but still firm labor-market report is unlikely to generate a strong reaction in markets.

A survey conducted by 22V Research showed most investors are watching payrolls closer than normal. Only 26% of the respondents think Friday’s data will be “risk-on,” 40% said “risk-off,” and 34% “mixed/negligible.”

“Investors are, once again, focused on payrolls Friday. But unemployment has jumped back into focus as expectations for the ‘Urate’ have skewed higher,” said Dennis DeBusschere at 22V.

One key area to watch will be the average hourly earnings measure, which has ticked higher in recent months, fueling concerns about accelerating pay growth and potentially limiting the Fed’s scope to cut rates further if it continues, according to Matthew Weller at Forex.com and City Index.

“Traders are skeptical that the Fed will deliver much in the way of additional interest-rate cuts this year,” Weller said. “With a handful of jobs and inflation reports still to come before the proverbial “rubber meets the road” for the US central bank, this week’s jobs report may not be as market moving as other, more immediately impactful releases.”

Since mid-September, the Fed has cut rates by 100 basis points. Yet the yield on 30-year Treasury bonds has risen by around the same amount. This divergence between short- and long-term rates is counterintuitive and far from isolated, with UK 30-year yields soaring even as the Bank of England eases monetary policy.

The reason: Investors are worried that the inflationary pressures sparked by the pandemic will linger in the global economy for years. And what’s more, governments that spent heavily to stimulate economies during coronavirus lockdowns are still borrowing lots of money.

“The backup in bond yields since mid-September did not surprise us,” said strategists at Yardeni Research. “But it has surprised lots of other financial pundits, who are warning that this could be bad news for stocks. It could be, especially if the 10-year US Treasury bond yield revisits last year’s high of 5%. That would probably bring a buying opportunity in the bond and stock markets.”

Yardeni bets that bond yields have normalized. The 10-year yield should range between 4% and 5%, as it did in the years before the ‘Great Financial Crisis’, the strategists noted.

Top Fed officials — including Chair Jerome Powell — are increasingly pointing to an obscure price gauge as a reason to maintain confidence in their outlook: “market-based” inflation.

The metric excludes a range of services where data-collectors can’t directly measure prices and have to estimate them instead. The result is a different inflation picture in recent months. Whereas the central bank’s preferred underlying inflation gauge accelerated to 2.8% in November, the market-based measure has been more or less flat at 2.4% since May.

“We think inflation is likely to trend lower in the first half of the year, keeping gradual cuts in place, before restrictive trade policies halt disinflation—and further Fed cuts — in the second half of the year,” said Michael Gapen at Morgan Stanley.

“Options on SOFR futures are pricing for the Fed to cut once more and be done for the year, according to our risk-neutral distribution model,” said Ira Jersey and Will Hoffman at Bloomberg Intelligence.

The model shows the mode of the probability distribution is for the central bank to cut only once more, and prices only a 10% chance that interest rates will be lowered to what was priced in September 2024 when the Fed began easing. Prior to the September payroll report released Oct. 4, options were pricing for a 20% chance the Fed would cut to below 2%. Today, the odds are less than 5%.

“The market is now pricing for a 30% chance of rate hikes by year-end,” they noted. “Given that, the yield-curve steepening makes sense, and could extend if the economy remains steady. As recently noted, we think the primary reason for the long-end selloff has been the repricing of Fed terminal-rate expectations.”

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