The primary driver of movement in the bond market this week was always going to be the July employment situation report, which came out this morning and showed that the U.S. economy added 528,000 jobs over the past month. Expectations were for the economy to have added 230,000 jobs after adding 372,000 in June. This is the highest monthly jobs gained in five months and the unemployment rate ticked down to 3.5%. The report has large implications for the near-term path of Fed rate hikes and MBS pricing. The recent rally in the bond market was due to investor hope that the Fed would be less aggressive going forward. That will not be the case.
The labor market is still strengthening, not weakening, which is consistent with an economy in expansion during an inflationary boom. Talk of a recession is premature. The report, which is the latest chance to gauge the strength of the U.S. economy, makes the Fed’s job harder, as a booming labor market will likely force the Fed to raise rates by 75 BPS for the third consecutive time at its next meeting in September. Wage growth, which climbed 0.5% for the month (picking up from 0.3% in June) and 5.2% over the last year feeds into the narrative that we are yet to reach peak inflation.
The strong payrolls report validates the Fed’s view of a resilient economy that can withstand additional rate hikes. Bond yields had been falling on the hope that the Fed will pivot to a more normal policy as the economy weakens, but the report endorses much of this week’s Fedspeak that sought to jawbone rate expectations. A handful of Fed officials this week reiterated the central bank’s resolve to bring down high prices; St. Louis Fed President Bullard said that the central bank will continue raising rates until it sees compelling evidence that inflation is falling. He added that he expects roughly another 1.5 percentage points of interest rate increases this year. Minneapolis Fed President Kashkari said that the central bank is committed to doing what is necessary to bring down demand to reach policymakers’ 2% long-term inflation goal, which remains far off.
This payroll report shows that Fed has a lot more work to do in getting aggressive and pushing up rates, which makes the “soft landing” scenario seem less likely. Expectations for Fed policy have already been recalibrated, with a hike of 0.75% the most likely scenario at the September meeting as the central bank fights inflation. Treasury prices sank in the wake of the report. There will be one more jobs report released before the September FOMC meeting, but this report confirms the need for the Fed to continue tightening, and Fed officials have come out in favor of front-loading rate hikes during this tightening cycle.
While the possibility of a dovish pivot that Fed Chair Jerome Powell hinted at last week has diminished, volatility persists in the bond market. Looking for more tips on how to navigate this period of increased volatility? Hopefully, you attended our webinar on Improving Profitability to Counter Market Headwinds. We have also published several blogs over the last few weeks, including Strategies for Mitigating Risk in a Volatile Market, which provide more subject matter on the current market. As always, contact us if you are looking for a better suite of secondary marketing products or more guidance on how to manage market volatility.