The Day Ahead: How Much Higher Can Rates Go if NFP Beats?

Today we will receive long-awaited data that does more than anything else to confirm or reject the notion of September tapering than anything else between now and the potential announcement on September 18th itself.  One discussion that continues to come up on the MBS Live dashboard asks how much higher rates can go.  Isn't a September tapering already priced in to the market? 

In a word, no.  It can't possibility be priced in because of today's data.  Recall the magnitude of the miss and beat in April and May on the jobs data.  April was much weaker than expected and May was ridiculously stronger-than-expected.  In gearing up for what will be the final vote on 'Sept-taper,' markets have to consider that they're greeted with a similarly wacky NFP print, or that today's revises the last few into clearly stronger or weaker territory.

Until such a thing can be ruled out, it must necessarily be a part of the trading strategy.  We can safely conclude that stronger economic data beyond a certain point is no longer cause for additional bond market weakness because the weakness is a factor of Fed tapering, not of chasing economic strength.  Additionally, if rates rise too much, too fast, it could cause problems for the recovery that ostensibly was strong enough to push rates too high, too fast.  There must be some law against that.

Rates aren't evolving higher to future economic realities.  Rather, prices are devolving lower, disavowing their allegiance to the proverbial punch-bowl.  Once they've put enough distance between themselves and the punch-bowl, it doesn't behoove them to move any farther away.

We're probably getting close to "far enough away," but until markets no longer have to worry about potentially pushing back tapering beyond 9/18, we can't know what "fully-priced-in" looks like.  In other words, NFP has to "not miss by too much."  If it's close enough to consensus, tapering is confirmed and we sell-off further, bringing 10's up into the 3.08-3.23 range before the next notable consolidation. 

There are always multiple approaches when considering what markets might do in the future, so 3.08-3.23 is just one very basic way of looking at a few long term trends, including pure horizontal pivot points, as in the following chart.  But either way, bond markets would need a big enough miss to give pause to the notion of Sept-taper in order NOT to move up into the 3's today.

What's the magic line in the sand for NFP?  with a 162k previous reading and a 180k forecast, any "miss" that falls between those two figures isn't enough of a miss to offer salvation for interest rates.  There's probably another 10k of overrun below 162k where the response is positive, but equivocal.  Anything over 162k with strong internals/revisions or over 180k with average internals/revisions isn't likely to help.  All that having been said, we're probably very close to the point where a bit of extra weakness (higher rates) brings about a pause for reflection at the very least.  In a weird way, we need to go a bit higher in rate, before we can go lower, perhaps.  There's sound reasoning behind that philosophy, but the bigger questions are "how much lower would that ultimately be?" and "how much higher do we need to go before we get to find out?"  Maybe we'll find out today.