MBS Morning: 7 Charts to Help Make Sense of Paradoxical Jobs Report Reaction

Nonfarm Payrolls came in at 235k versus a median forecast of 728k.  Poll a hundred market strategists about the likely market impact and 99 of them would tell you a bond rally would be all but guaranteed and that stocks would be soaring on expectations of prolonged Fed accommodation.  While many of those strategists will be expending significant effort on making sense of this today, several key points have already emerged (with the truth likely being some combination of the following).  

Sector-Specific Drama

Today's "miss" is concentrated in Retail Trade and Leisure/Hospitality--sectors that had been chugging along nicely before the surge of the Delta variant. Given early indications that the current upward trajectory in case counts may be leveling off, the labor market could already be much tighter than the 235k headline suggests.  

In other words, take away delta, add back a conservative amount of jobs based on recent low-case-count months, and this suddenly looks like a much stronger jobs report.  Indeed, the relationship between the payroll count and covid case counts is very consistent with last November.

Some analysts have suggested the other way to look at today's weak number would be as evidence that the post-covid economy simply doesn't have as many jobs to go around as the pre-covid economy.  Thus, the Fed would have to accept this as the new normal and move to taper sooner than later.  But Job Openings data disagrees with that theory:

Another key observation involves the shape of the yield curve today.  Specifically, 2yr Treasuries are not weaker on the day as investors push out Fed rate hike expectations (but at the expense of the longer-end of the yield curve).  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 on from obsessing over the timing of Fed tapering and is now focusing more on the timing of the lift-off in the Fed Funds Rate. But justifying this move would require inflation to accelerate in a more troubling way.  Some analysts expressed concern over the big increase in average hourly earnings in today's jobs report for exactly that reason (i.e. higher wages = higher inflation). 

While this is great in theory, the post-covid reality has consistently shown price pressures to be a factor of limited SUPPLY as opposed to excess demand.  In any event, the market simply isn't pricing in any major inflation drama.  The green line below shows market-based inflation expectations (the difference between Treasury yields and their inflation-protected counterparts).  

In looking at the chart above, the mind's eye may be tempted to see some converging lines surrounding recent movement in 10yr yields.  The following chart shows that convergence and offers yet another approach to explaining away today's counterintuitive movement (i.e. it doesn't really matter if it's still so perfectly contained by the consolidation range).

But the last chart is probably the most compelling.  It also relies on the simplest explanation.  Quite simply: the market seems to be reading today's jobs report as being better than the headline suggests.  That inference relies on the fact that both stocks and bonds lost ground simultaneously (and fairly symmetrically)--a pattern that typically plays out when traders are adjusting their stance on Fed accommodation.  The only counterpoint would be that we've seen other examples of money moving out of both sides of the market ahead of a 3-day holiday weekend. 

Speaking of next week, there's another compelling consideration that can't be shown in a chart.  It has to do with the scheduled Treasury auction cycle (3yr, 10yr, and 30yr).  Of the 2 types of auction cycles, this is the tougher one for the market to digest (the other version is 2, 5, and 7yr... It's easier to know how to bid on shorter duration bonds).  It's not uncommon to see bonds give up some ground on the Friday before a 3/10/30yr auction week.  Many traders may have been waiting to make that move until after the jobs report.