Bond traders to face a reality check with jobs report

Friday’s report is expected to show moderating employment and wage growth in November but no major deterioration in hiring. Given the recent run-up in bonds, there’s a risk of a market reversal – at least initially – on any surprises that challenge traders’ bullish narrative.

“This rally in Treasuries needs to be validated,” said Kevin Flanagan, head of fixed-income strategy at WisdomTree. “The bar has been raised now in terms of the economic and inflation numbers coming in, and they’re going to have to show that the momentum of a slowdown is picking up.”

Payrolls probably grew by 185,000 last month, after increasing 150,000 in October, while the unemployment rate held steady at 3.9 per cent, according to the median forecast of economists surveyed by Bloomberg.

The end of strikes by autoworkers and Hollywood actors boosted payrolls last month by 41,300 after depressing them in October, according to the Bureau of Labour Statistics. After taking that into account, the underlying pace of payroll gains looks to be slowing.

A resilient jobs report “will continue to provide the Fed with cover as to not have to move prematurely in cutting rates”, said Mr Flanagan.

It would also highlight a bond market perhaps running too far ahead of the central bank, and in danger of repeating a pattern seen during this latest tightening cycle of betting too soon on a Fed course change.

On Thursday, a largely in-line report on US jobless claims left market expectations intact. The debate remains about the scale of rate cuts, an outcome ultimately driven by how much hiring and inflation slows. With a 10-year yield now below 4.2 per cent, he said, “the market seems to be priced for a strong near-term deterioration”, said John Brady, managing director at RJ O’Brien.

Fed meeting

Fed officials are observing a self-imposed quiet period ahead of next week’s policy meeting, which also coincides with fresh data on US consumer prices. Armed with the latest jobs and inflation reports, the central bank will update its quarterly summary of economic projections and predicted path of interest rates.

Fed watchers believe the central bank will leave policy steady at its meeting next week and that its next move will be a cut. Some opined that Fed officials are not pushing back hard against expectations of easing next year because that is the same direction they think policy is ultimately headed.

In almost any economic scenario – crash landing, soft landing, or no landing – inflation is likely to keep decelerating next year, driven by ebbing rental costs, Bank of America chief US economist Michael Gapen said. He expects Fed officials to pencil in three rate cuts for 2024 in the summary of economic projections they’ll release next week. “I’m calling it a shift from a hawkish hold to a dovish hold,” he said.

Subadra Rajappa, head of US rates strategy at Societe Generale, told Bloomberg Television they expect 150 basis points of cuts next year, with “a recession penciled in”. She said “risks are skewed asymmetrically in rates to the downside”, and they expect 3.75 per cent on the 10-year by mid-2024.

The asymmetry means even a solid payroll number may only spur a limited rise in Treasury yields as traders stick to their guns and expect a slowing economy gathering momentum.

The market has “gone from a mode of selling into strength to now buying on the dips”, said Mr Flanagan. Still, “to break through 4 per cent on 10-year yields, given what has been priced now, you are going to need to see genuine signs of a hard landing at this stage of the game”, with payrolls either negative or barely positive.

Bloomberg