It’s been a busy week of economic data with several reports relevant to the housing market. This Friday’s job report was not only the all-time top dog among economic reports, but also significant because of its role in the Federal Reserve’s decision-making process.
The Fed is widely expected to announce an imminent reduction (also known as “tapering”) of its bond-buying program by the end of the September political session.
But the strength of the job report is controversial. As for headline employment numbers, the number of nonfarm payrolls (NFP) was 235,000 versus an average forecast of 728,000. That’s a big miss!
Ask a hundred market strategists about the likely impact on the market and 99 of them would guarantee you a rally in the bond market (which is good for interest rates). However, as it happened, bonds lost ground according to the job report. It was, of course, a counterintuitive result, and experts rushed to understand it on Friday morning. Here’s a quick rundown of the explanations (with reality likely being a combination of all of them).
Friday’s “miss” focused on retail and leisure / hospitality – sectors that had fluctuated well prior to the delta boom. It’s a bit early to say we turned a corner on the daily case count, but the pace has slowed down. If this continues, it will mean a quick return to stronger numbers (as job losses were not broad-based but focused on sectors hardest hit by Covid).
In other words, take away Delta and that suddenly looks like a much stronger job report. In fact, the relationship between the number of payrolls and the number of Covid cases is very much in line with that of last November.
Labor market tighter than expected?
Some analysts have suggested looking at Friday’s weak number differently would be evidence that the post-Covid economy just doesn’t have as many jobs as the pre-Covid economy. Therefore, the Fed would have to accept this as the new normal and move to a taper sooner rather than later. Interesting theory, but contradicting current data on job vacancies:
This only reinforces the likelihood that the low pay count reflects a passing Covid-powered reality.
Forget about tapering. What about tariff increases?
Another important observation concerns the difference between longer-term and shorter-term bonds. Specifically, were 2-year government bonds not weaker during the day. This coincided with investors who drove the Fed’s rate hike expectations behind.
The Fed Funds rate correlates with bonds with shorter maturities such as 2-year Treasuries. And sometimes traders express their preference for shorter-term bonds at the expense of longer-term bonds like 10-year Treasuries or MBS (the mortgage-backed securities that underlie mortgage rates). This is an ongoing trend in Q3 – one that coincides perfectly with the proliferation of the Delta variant.
The tangential implication is that the bond market has largely moved away from obsession with the timing of the Fed throttling and is now more focused on the timing of the Fed funds rate hike. However, to justify this move, inflation would have to accelerate in more worrying ways (as inflation is one of the two main drivers driving Fed policy changes).
Inflation considerations in average income data
For this very reason, some analysts expressed concern about the sharp rise in the average hourly wage in the job report (ie higher wages = higher inflation).
While this is great in theory, post-Covid reality has shown time and time again that price pressure is a factor in limited SUPPLY as opposed to excess demand. In any case, the market is simply not pricing in a major inflationary drama. The green line below shows market based Inflation expectations (the difference between the yields on government bonds and their inflation-protected counterparts).
Avoid reconsidering the step and focusing on the consolidation pattern
Looking at the graph above, the mind’s eye may be tempted to see some converging lines around recent moves in 10-year returns. The graphic below shows this convergence and offers another approach to today’s counterintuitive movement (i.e. it doesn’t really matter no matter how perfectly it is enclosed by the consolidation area).
Maybe it’s just better than it seems
But the last diagram is probably the most compelling. It also relies on the simplest explanation: the market seems to be reading the job report better than the headline suggests. This conclusion is based on the fact that stocks and bonds have both lost ground simultaneously (and fairly symmetrical) – a pattern that usually plays out when traders adjust their stance to adjust the Fed.
This agrees pretty well with the starting point that retail and hospitality / leisure are driving the weakness. It also recognizes other parts of the report such as the low unemployment rate of 5.2% and stronger average hourly earnings data.
Last but not least: Treasury Supply next week
Speaking of next week, there is one more compelling consideration that cannot be graphed. It has to do with the planned treasury auction cycle (3 years, 10 years and 30 years). Of the 2 types of auction cycles, this is more difficult for the market to digest (the other version is 2/5/7 years and it is easier to bid on bonds with shorter maturities).
It’s not uncommon for bonds to give way a little on the Friday before a 3/10/30 year auction week. Many traders may have waited until after the job report to take this step. The Treasury supply issue is even more plausible when you consider that MBS wasn’t nearly as bad on Friday. In fact, the average lender was pretty close on Thursday in terms of interest rate offers, staying in the all-time low.
Other dates this week
It was a mixed mix for the property market as home prices continued to rise at a ridiculous rate. Actually, they could have been checked …
Tight inventories – the main culprit for the price spike – are also blamed for the decline in outstanding home sales.