Baker Market Update – wk220401

Today’s Employment Report all but ensures the Federal Reserve will hike rates by 50bp in May for the first time in 22 years. No, that’s not an April Fool’s joke, just my opinion based on a few factors:

  1. Job growth is strong. The economy added 431,000 jobs in March and although that was less than expected, it continued a streak of 11 months in a row the economy has added at least 400K jobs, something we haven’t seen since the 1930’s.
  2. The labor market is tight. The Unemployment Rate fell to 3.6%, 0.1% more than expected and just 0.1% above the 50-year pre-pandemic low of 3.5%. If the Fed has a dual mandate of price stability and maximum employment, it’s hard to argue they haven’t achieved the latter (yes, I know what you might be thinking, there are a lot of people that have left the labor force… read on…)
  3. People are reentering the labor force at a rapid pace. The Labor Force Participation rate has jumped 0.7% in the last 5 months to 62.4% and is now just 1% below the pre-pandemic peak of 63.4%. By comparison, the participation rate was 61.7% in August of 2020 and was still at 61.7% in October of 2021 so the recent 5-month surge in participation is impressive compared to the prior 14 months that showed no growth.
  4. Wages are strong. Average hourly earnings rose 0.4% in March and are up 5.6% year-over-year, the fastest pace since May 2020 when the wage data were skewed by covid shutdowns that removed lower paid workers from the averages.
  5. This is the last Employment Report the Federal Reserve will see before the FOMC meets again on May 4th so the strength in jobs, tight labor market, rising participation and surging wages will heavily influence their decision for how much to raise rates.
  6. The next CPI report (April 12) will be the hottest in decades, most likely showing an annual CPI of 8-9%.

The final reason I believe the Fed will raise rates 50bp on May 4th is simply because the market has already priced in an aggressive tightening so why not? The 2-year Treasury yield is up an astonishing 173bp since January 1, more than tripling its yield to 2.46%. Mortgage rates have surged more than 150bp this year to 4.9% which is actually higher than the 4.82% peak in 2018 when the Fed Funds rate hit 2.5%. The damage to the economy and consumer spending from higher rates is already being felt so the Federal Reserve has nothing to lose by raising rates 50bp in May. Does that mean bond yields will continue to rise higher if they do? Not necessarily. The market has already priced in an aggressive tightening cycle so yields should only rise further if the market begins to believe the Fed will take the funds rate to 3% or higher… and that is not yet priced in.

Treasury Yield Curve Change – Year-To-Date

Source: Bloomberg, L.P.

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