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How Far Can Bonds Keep Falling in the Face of Persistent Labor Market Strength?

Published 10/04/2023, 09:38 AM
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Stocks and bonds fell sharply on Tuesday following the release of jobs data that strengthened the case for the Federal Reserve to maintain higher interest rates for an extended period.

In the currency market, the Japanese yen trading was marked once again by significant volatility, surging from nearly one-year lows against the dollar amid speculation that Japanese authorities might be taking steps to prevent further depreciation of the currency.

The S&P 500 dropped 1.4% while Nasdaq lost 1.9% as investors continued to rebalance their portfolios to account for higher bond yields. The yield on a 10-year U.S. government bond continues to surge, printing levels around 4.9% – a fresh 16-year high.

The release of the August JOLTS report comes just a few days ahead of the Department of Labor's nonfarm payrolls report for September, which is scheduled for release on Friday. Economists surveyed by Dow Jones anticipate that the nonfarm payrolls report will show an increase of 170,000 jobs for the month of September.

"Friday's payroll data should help clarify if the labor market is as strong as the JOLTS report implies, because at this stage of the Fed's 'last mile' to untangle the remaining 'sticky' inflation, a stronger than expected report will be the last thing the Fed wants to see, not to mention financial markets," said Quincy Krosby, chief global strategist at LPL Financial in Charlotte, North Carolina.

Stocks Hit as Fresh Data Strengthens Case for More Hikes

The major stock indices briefly attempted to rebound in early Tuesday trade. However, this rally effort was abruptly undercut by the release of the hot JOLTS (Job Openings and Labor Turnover Survey) report yesterday. The report revealed a significant increase in job openings, with 9.61 million reported in August, up from 8.9 million in July and well ahead of the Street's expectations of 8.81 million.

The largest increases in job openings were seen in professional/business services (+509,000), finance/insurance (+96,000), and state/local government (+76,000). It seems that the unexpected increase in U.S. job openings based on the JOLTS data for August was primarily driven by a surge in white-collar job postings, indicating sustained labor demand.

The increase in job openings reported in the August JOLTS data was primarily driven by small businesses with fewer than 10 employees. These smaller enterprises accounted for the majority of the rise in job openings. Medium-sized businesses also reported substantial increases in job openings, while the rise for large corporations was relatively modest.

Hence, bond yields were surging while stocks took a strong hit as the latest JOLTS data prompted swaps traders to raise their expectations of a Fed rate hike in December to over 50%. Investors have been moving away from Treasuries for several weeks, and the robust JOLTS report provided another reason for yields to continue their recent move higher.

"The reversal reinforces the case for a November Fed hike," said Jonathan Millar, a senior economist at Barclays in New York.

Moreover, this report marked the second piece of strong economic data in as many days, following Monday's manufacturing ISM (Institute for Supply Management) data. Taken together, the last batch of economic data has raised concerns among investors that the Fed may be forced to deliver more rate hikes in the coming months.

The JOLTS data highlights the economy's resilience, potentially reinforcing the Federal Reserve's commitment to a hawkish monetary policy. The increase in yields has been reducing the appeal of growth stocks, but also for dividend payers. On Monday, the Utility stocks got crushed as investors opted to sell dividend-paying shares and shift their investments toward safety and higher yields in the current market environment.

“You have to compare their yield to what you can get from a risk-free asset in government bonds,” said Gregg Abella, chief executive of New Jersey money manager Investment Partners Asset Management. “As that gets repriced, it’s hard to know where the bottom is.”

The JOLTS data also aligns with signals from the latest U.S. GDP data, which emphasized the impact of government spending on economic growth. This further supports the argument for higher interest rates over an extended period, leading to increased yields and more weakness for the stock market.

Bond Market in the Driving Seat

Stocks have been surging in recent months amid widespread AI optimism, as well as the belief that the Fed will ultimately be able to engineer a soft landing. However, this abrupt increase in long-term interest rates to their highest levels in 16 years is raising concerns and challenging investor expectations for a soft landing.

This surge in rates is occurring at a time when inflation has started to ease, and the Fed has indicated that it is nearing the end of its rate-hiking cycle. While higher interest rates can help combat inflation, the speed and magnitude of the recent increase could potentially disrupt economic stability and create challenges for borrowers, including consumers and businesses.

Another factor to consider when looking at surging yields is that a sustained increase in Treasury yields carries significant implications for the U.S. government. As yields rise, the government faces higher borrowing costs, which can strain its budget and fiscal outlook.

This is just another big risk for the Fed to consider when its FOMC meets in November to decide on the next monetary policy steps.

“We’re going to have to watch it,” Cleveland Fed President Loretta Mester told reporters Tuesday. “Those higher rates will have an impact on the economy, and we just have to take that into account when we’re setting monetary policy.”

Summary

Despite the Federal Reserve's efforts to slow the economy through various policy measures, the strength of the labor market persists. The latest JOLTS report for August yielded showed a surge in employment vacancies at U.S. businesses, which may ultimately prove to be a tipping point for the Fed to deliver at least one more hike before the end of this year. As a result, stocks and bonds fell following the report as the Fed may not be able to engineer a soft landing after all.

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Shane Neagle is the EIC of The Tokenist. Check out The Tokenist’s free newsletter, Five Minute Finance, for weekly analysis of the biggest trends in finance and technology.

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