It has been a busy week for economic data, with several reports pertaining to the housing market. The employment report this Friday was not only a consistent leader among economic reports, but also especially important because of its role in the decision-making process of the Federal Reserve System.
By the end of the year, the Fed is expected to announce an upcoming cut (so-called “narrowing”) of its bond buying program. If the jobs report were strong enough, investors thought the Fed would make this announcement in a few weeks. September political meeting.
But the power of job reporting is highly controversial. As for the total number of vacancies, the number of jobs in the non-agricultural sector (NFP) amounted to 235 thousand against the average forecast of 728 thousand people. This is a big setback!
Ask a hundred market strategists about the likely impact on the market, and 99 of them will guarantee you the growth of the bond market (which is good for betting). However, it so happened that bonds lost ground after the job posting report. Of course, this was an illogical result, and on Friday morning the experts rushed to figure it out. Here’s a quick overview of the explanations (in fact, it’s likely some combination of all of them).
Friday’s blunder focused on retail and the leisure / hospitality sector, sectors that did well prior to the surge in the Delta variant. It’s too early to tell that we have turned a corner in the daily count of cases, but the pace is slowing down. If this continues, it means a quick return to stronger performance (as job loss was not widespread, but concentrated in the sectors most affected by covid).
In other words, remove the delta and this report will suddenly become stronger. Indeed, the link between payroll and covid cases is very consistent with last November.
Is the labor market harder than it sounds?
Some analysts have suggested that another way to look at Friday’s weak data would be evidence that there simply aren’t as many jobs in the post-dock economy as there are in the dock-dock. So the Fed will have to accept this as the new norm and move on to cutting emissions sooner rather than later. Interesting theory, but recent job data is inconsistent:
This only confirms the likelihood that the low payroll reflects the temporary reality caused by the covid.
Forget about narrowing. What about rate hikes?
Another key observation concerns the difference between long-term and short-term bonds. Specifically, 2-year Treasury bonds were No weaker daily. This coincided with investors denying expectations of a Fed rate hike.
The federal funds rate correlates with bonds with a shorter maturity, such as 2-year Treasury bonds. Sometimes traders prefer bonds with a shorter maturity to the detriment of bonds with a longer maturity, such as 10-year Treasury bonds or MBS (mortgage-backed securities that underlie mortgage rates). This is an ongoing trend in the third quarter that matches perfectly with the proliferation of the delta variant.
An indirect consequence of this is that the bond market has largely moved away from the obsession with the timing of Fed cuts and is now focusing more on the timing of the federal funds rate hike. But justifying this move would require accelerating inflation in a more alarming way (as inflation is one of two key factors influencing the Fed’s policy change).
Inflation Factors in Average Income Data
Some analysts have expressed concern about the significant increase in average hourly wages in the jobs report for this very reason (i.e. higher wages = higher inflation).
While this is fine in theory, post-covid reality has consistently shown that price pressures are a factor in limited SUPPLY, not excess demand. In any case, the market is simply not involved in any major inflationary drams. The green line below shows the market inflation expectations (the difference between the yield on Treasury bonds and their inflation-protected counterparts).
Avoid over-thinking the move and focus on the consolidation pattern
Looking at the chart above, it might be tempting to see some converging lines surrounding the recent 10-year yield movement. The following diagram illustrates this convergence and offers another approach to explaining today’s counterintuitive movement (i.e. does not matter if it is still so perfectly held by the consolidation range).
Maybe this is better than it sounds
But the last chart is probably the most compelling. It is also based on the simplest explanation: the market seems to read the job report better than the title suggests. This conclusion is based on the fact that both stocks and bonds have lost positions. simultaneously (and quite symmetrically) – a pattern that usually occurs when traders adjust their stance against a Fed placement.
This fits quite well with the initial view that the retail and hospitality / leisure sectors are the cause of weakness. It also mentions other parts of the report, such as a low unemployment rate of 5.2% and more reliable data on average hourly wages.
Last but not least: Treasury proposal next week
Talking about next week, there is another important consideration that cannot be captured in a chart. This is due to the planned cycle of treasury auctions (3 years, 10 years and 30 years). Of the two types of auction cycles, the market is harder to digest this one (the other is 2/5/7 years, and it is easier to bet on bonds with a shorter duration).
It is not uncommon to see bonds drop out on the Friday before the 3/10/30 auction week. Many traders may have been waiting for this move before the vacancy report was released. The Treasury bond supply problem becomes even more likely when you consider that MBS did not have such a bad day on Friday. In fact, the average lender was fairly close to Thursday in terms of offering interest rates, thus remaining at a historically low level.
Other data this week
This was controversial for the housing market as house prices continued to rise at an incredible rate. Actually, maybe they went to the plaid …
Inventory shortages – the main culprit behind rising prices – are also the main reason for the decline in unfinished home sales.