The Day Ahead: Jobs Report to Preside at Bond Markets' Sentencing

Kicking the can down the road was all the rage a few days ago when the cliche phrase was applied to the quasi-deal that softened the blow of the Fiscal Cliff.  But we've quickly moved on to the next "kicking" analogy.  Not to put too fine a point on it, we must now consider whether or not Friday's Jobs report will kick bond markets while they're down.

The Employment Situation Report isn't the be all and end all for mortgage rates, but it's always a tremendously important market mover, and clearly the most dominant piece of scheduled economic data each month.  This time around, it happens to fall on the morning following a series of sell-offs for bond markets with the most recent one being a doozy.  This casts the jobs report in the role of a "sentencing judge" vs the FOMC minutes that acted more like a jury that read the verdict.

FOMC Minutes didn't preemptively suggest themselves as a focal point of Thursday's trading, let alone the cause for a major sell-off.  In hindsight, however, they dominated the session and now have a chance to be the event that caused a confirmed breakout of the longer term range we'd been considering coming into the session.  Here's an updated version of yesterday morning's chart, showing the break above 1.865 in 10yr yields:

While those are the highest yields since May for Treasuries, MBS maintain a good amount of relative benefit from QE3.  Thursday's selling took prices right back to their lowest closing levels since QE3!

So here we are...  The verdict has been read...  Bond Markets were found guilty of "feeling too complacent and/or assured about the FOMC's collective attitudes regarding the seamless continuation of Quantitative easing measures."  Now it's time to find out if anyone gives a damn.  In truth, the "judge" isn't simply the jobs report, but a combination of that data and the market's collective reaction.  This judge will either laugh at the jury's silliness and hand down a light sentence, or an example may be made of poor poor bond markets.

If this all seems a bit melodramatic, it certainly is!  No one thinks the Fed is going to pull the plug on QE3 any time soon and that's not what Thursday's sell-off was about.  It was simply a logical drop in the net-present-value of bond prices based on the adjustment of future assumptions from certainty and confidence to "less certainty and confidence."   Bottom line, smooth sailing for QE3 and QE4 through 2013 is slightly less of a sure thing after the FOMC Minutes, and bond prices adjusted accordingly.  If Friday's NFP happens to knock it out of the park, there will be a momentum consideration that could lead to things getting very ugly, very quickly.

That said--and perhaps this is just the wishful thinking--there does seem to be some reservation in the market about stampeding through 2% 10yr yields or barreling toward 103-00 in Fannie 3.0s.  Be aware, both of these nasty levels are possibilities, but at least equally possible is the eventuality that NFP is moderate or weak, and that helps bond markets hold their ground.  The unpleasant fact about either scenario is Thursday's price action suggests that we consider the possibility of a negative shift in longer term trends, and that's something that will have to be disproved before becoming less of a concern.