The jobs report was a relief, not a revelation

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Good morning. US dock workers have reached an interim agreement with their employers, taking a nasty inflation risk off the table before we have a chance to worry properly. If you were one of those hoarding toilet paper in anticipation of the strike, well, the next crisis is never far away. Email us doomsday prep tips: [email protected] and [email protected].

The jobs report was good, but not that good

Last Friday’s jobs report showed the economy added 254,000 jobs in September, well above expectations, and unemployment fell from 4.2 percent to 4.1 percent. Moreover, the anemic figures for July and August were revised up by 55,000 and 17,000 respectively, easing a slowing trend that helped the Fed to cut interest rates by 50 basis points.

The general queue of joy. Chicago Fed President Austan Goolsbee called the report “superb” in an interview with Bloomberg TV. Shruti Mishra, US economist at Bank of America, called it an “A+ report”. Others suggested it was the end of recession fears.

All of these are a bit rich. The picture has not changed that much. Last month I wrote, “whisper, sing, get a tattoo: no recession on the horizon just yet.” That remains true. What we got from the jobs report is a confirmation of what many other data have suggested. GDP growth was robust at 3.0% (unrevised) last quarter, and September ISM surveys were strong, especially for new orders. And so on.

Our data interpretation motto is “a month is just a month”. OMIJOM keeps good and bad news. We still don’t have much of a grasp of the post-pandemic economy, and labor force data has been particularly mixed and difficult to read.

Earlier this year, the Bureau of Labor Statistics revised down the previous year’s estimates by about 818,000 jobs because of structural problems in their birth-death model. This year’s numbers could be subject to extensive revisions, too. And while 254,000 new jobs is a significant improvement from August’s 159,000, it may not be that good of a number. As I wrote recently, immigration has boosted the U.S. labor force, and the number of break-even jobs — the number of new jobs needed each month to avoid a rise in unemployment — may be closer to 230,000. rather than earlier estimates of 100,000.

In any case, this report marginally shifts the Fed’s focus away from recession fears and gently nudges it toward concerns about re-accelerating inflation. For now inflation seems very close to being beaten, but not completely. One factor still troubling is wage growth, which has stalled at 4%, a percentage point above the pre-pandemic trend, for six months. Further conflict in the Middle East could also boost oil prices. Breakeven measures of inflation are rising.

These lingering worries, though small, are enough to lower the table in November by 50 basis points. We may be closer to the neutral rate than previously thought, and the FOMC will want to proceed with caution. The futures market moved almost entirely in anticipation of a 25 basis point cut next month:

A few more good jobs reports and a slight decline in wages, and Unhedged will be ready to join the celebration.

(Reiter and Armstrong)

What happens at the long end of the curve?

It’s not a huge move, but it’s big enough to require an explanation: Long-dated Treasuries are selling. Yields started rising the day before last month’s Fed meeting and haven’t let up. Here are the 10 years:

This is slightly counter-intuitive to the extent that long interest rates are composed of expected short rates, and short rates are falling. It’s also little surprise that when the Fed cut 50 basis points, yields rose, and then when the strong jobs report came out – which reduced the chances of another 50 basis point cut – yields rose again.

The movement in real rates was greater than in nominal rates. Since the 16th of last month, real yields (inflation-protected 10-year Treasury yields) have risen 19 basis points. Nominal yields rose another 15 basis points.

There are several possible explanations:

• Both the 50 basis point cut and the strong jobs report could have been interpreted as signaling a low chance of a recession. This makes Treasuries less attractive and risky assets like corporates and stocks more so. Any portfolio rebalancing towards risk would have been exaggerated if shorter-term investors had bet heavily that jobs data would continue to be weak and the Fed would have to taper quickly. Capital Economics’ Joe Maher points out that the good jobs report was supported by other strong data and raises the question of “whether the Fed needs to taper at all in November.”

• The market may be getting a little nervous that the Fed is cutting too much — and so rates will need to be higher next year and beyond. Anshul Pradhan and his team at Barclays note that “a reaction function of the Fed to economic resistance actually advocates higher rates. . . 10-year yields are still about 20 basis points too low. . . The Fed has been more focused on (falling) inflation and continues to see the neutral rate as low.” A rise in the price of oil also helps keep the risk of a resurgence of inflation on the agenda.

• The market can price in higher rate volatility, which requires real and nominal rates to rise. This was suggested to us by Jim Sarni of Payden & Rygel, who wrote that “volatile nominal yields are to blame, as opposed to any deep dark theory about real rates. . . this yield volatility is expected. . . in the periods immediately following a major rate change.”

These explanations are not mutually exclusive. But we like the third explanation best because it incorporates the view that we are in a particularly uncertain time for rates as the Fed changes policy direction and the various effects of the pandemic continue to ease (every moment feels particularly uncertain while you’re living it, but we’d argue that it really is). It is worth noting that the Move Index of Implied Bond Volatility is not on an uptrend. But that may be because the index is looking at one-month options on various Treasury terms, and the market is taking a somewhat longer view.

A good read

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