October began with evidence of a continued steady economic expansion and signals from the Fed that “tapering” of their asset purchase program would likely begin in November. That thinking was bolstered by the data stream early in the week as Factory Orders, Core Capital Goods, and ISM diffusion measures for both manufacturing and service sectors showed steady though modest improvement. The bond market saw yields rise with the benchmark 10yr T-Note yield stepping up 10bps to 1.58% at the close Thursday. We got continued yield curve steepening as well as the 2yr/10yr yield spread widened out to 128bps. Everything seemed to be falling into place according to Jerome Powell’s plan. Then came the labor department’s jobs report for September which threw a bit of a wrench into things.
The US economy created 194K new payrolls last month. Not a bad data point in normal times, but far below the expected 500K or the six-month average of 681K coming into the day. Upward revisions to the two prior months of 169K softened the blow somewhat, and the unemployment rate actually fell to 4.8%, the lowest level since the early days of the COVID pandemic. Wage growth was up slightly as expected at 4.6% year-over-year, and the “underemployment” rate that includes part-timers wanting full-time work dropped down to 8.5%, also the lowest in a year and a half. The most disappointing component of the report was labor force participation which actually ticked down to 61.6%, still more than 2.5% below pre-pandemic levels and a reflection of the lingering supply-side challenges of the labor-market recovery. This, despite all the talk of expiration of enhanced unemployment benefits. Employers may feel continued pressure to pay up for employers, forcing the Fed to stretch their definition of the time horizon that constitutes “transitory” inflation. The continuing impact of the Delta variant of COVID remains an obstacle to payrolls growth as well with leisure and hospitality employment up only 74K, and despite the reopening of schools for in-person teaching, overall education employment fell by 180K when seasonally adjusted. Sub-optimal for sure.
So given this hodge-podge, the question becomes… what’s a Fed to do? After some initial indigestion, the bond market seems to be at peace with the idea that tapering will still commence by year-end with a likely announcement in November. Pre-release chatter had coalesced around the idea that the jobs number would have to be really bad to derail the Fed’s timeline. This number was not good, but can’t be characterized as “really bad.” So, carry on. Nothing to see here. You can expect the FOMC to stay on course and execute the taper as planned while holding the Funds rate low for a good long time. As for the yield curve, steepening remains the order of the day.
US 2yr vs 10yr T-Note Yield Spread
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