Friday’s official job report is spurring a bit of a rethink about how quickly the Federal Reserve can cut borrowing costs, and pushing Treasury yields up by more than any time in months.
The readjustment of expectations briefly sent the policy-sensitive 2-year rate
up 17 basis points to above 4.74% in New York afternoon trading, leaving it on pace for the biggest one-day jump since May. The 10-year Treasury yield
also rose 12.6 basis points to touch 4.26%, heading for the largest daily gain since October.
In a nutshell, the solid jobs report — which showed an unexpected 199,000 new jobs created, the unemployment rate dropping to 3.7%, and average hourly earnings rising by a sharp 0.4% last month — is underscoring the higher-for-longer theme in interest rates. Before the data landed, many in financial markets had been set up for a scenario of a quick-and-easy return to lower interest rates and a faster slowdown of economic growth, job creation and inflation.
“The market wasn’t expecting a blowout report, but there were expectations for payrolls to moderate more than we saw, and they came in a bit hotter than expected,” said Michael Reynolds, vice president of investment strategy at Glenmede, which oversees almost $42 billion in assets.
“We think that even before this report, the market was getting way ahead of itself in calling for rate cuts,” Reynolds said via phone. Friday’s data “lends credence to the idea that the Fed is going to take it way slower on rate cuts than had been expected,” he said, adding that “wage growth could fuel inflation for some time here. It’s unlikely we will see another rate hike, but the Fed may be keeping rates higher for longer.”
Meanwhile, fed-funds futures traders dropped the likelihood of at least a quarter-point Fed rate cut by March to 45.6%, down from 64.5% a day ago, according to the CME FedWatch tool.
They also lowered the likelihood of their previous calls for up to five rate cuts to be delivered through the end of next year. While they are almost 100% confident that some form of rate cuts will arrive by December 2024, traders now see a 28.6% chance of five quarter-point cuts, down slightly from 30.6% a day ago. The fed-funds rate target currently sits at a 22-year high of between 5.25% and 5.5%.
Friday’s broad-based jump in Treasury yields left the policy-sensitive 2-year rate on its way toward its highest closing level in more than a week. In addition, both the 10- and 30-year yields
were on their way toward their highest two-day advances since October amid broad-based selling of government debt.
Whether solid job growth and wage gains will translate into stickier inflation remains to be seen.
The next major U.S. inflation update arrives with the November consumer-price index report released next Tuesday, a day ahead of the Fed’s policy announcement. Inflation as measured by the annual headline rate of CPI has remained at or above 3% for five straight months through October, although it’s fallen from a peak of 9.1% in June 2022.
“Evidence of rapidly cooling inflation suggests the Fed is likely to remain on the sidelines at next week’s policy meeting, though the labor-market endurance will lead Fed officials to retain some optionality for future rate hikes, if needed,” said Lydia Boussour, a New-York based senior economist at EY-Parthenon, the global strategy consulting arm of Ernst & Young. “We expect policy makers will resist talking about rate cuts until early 2024.”
After Friday’s job report, data from the University of Michigan showed that Americans’ inflation expectations over the next year fell to 3.1% from 4.5% previously. For the next five years, expectations fell to 2.8% from 3.2% in November.