By Serafino Tobia, Managing Director & Head of Agency CMBS Trading, Greystone
A bond-friendly US employment report this past Friday, May 3, has Treasury investors pivoting, anticipating a weaker economy and lower Fed Funds rates. The non-farm payroll report came in at +175,000 new jobs. Still solid job growth, but substantially lower than the market consensus estimate of +240,000 and last month’s outsized payroll of +303,000. The unemployment rate posted at 3.9%, 0.1% higher. Average Hourly Wages for the month were only +0.2%, also a bond-friendly number reflecting moderating wage inflation. As of May 6, 10-year Treasury yields are at 4.50%, lower by 11 basis points on the week; 2-year rates are at 4.81%, 17 basis points lower since last Monday close of business.
We’ve very likely printed the high-end of the recent range (10-year yield was at 4.70% and 2-year at 5% on April 25). We already had a big move in rates higher during the month of April (10-year rates were at 4.20% at the end of March). Also, the Fed is unlikely to move the Fed Funds rates any higher; Fed Chairman Powell said that multiple times at the press conference after the FOMC meeting last Wednesday, May 1.
The overnight Fed Funds rate is pegged by the Fed in a range of 5.25% to 5.50%, a level that the Fed views as restrictive (but the economy over the past year hasn’t flinched and remains strong). As you know, the Fed has a dual mandate (stable prices and full employment). On the employment front, the Fed is likely to keep rates steady until we see unemployment prints at 4.1% or 4.2%. Sub-200,000 monthly new jobs and 3.9% unemployment is in the right direction, but it’s only an increment. On the inflation front, the improvement on inflation has stalled so far this year. March Core PCE (without energy and food prices) printed at 2.8% year-over-year and +0.3% for March. The 3-month pace (annualized) of the Core PCE index moved from 1.6% as of December to over 4% for the 3 months ending in March.
Inflation stalling over 3%+ is a problem - the Fed will likely want to see a couple prints of Core PCE inflation at 0.2% month-over-month to trigger a cut in the Fed Funds rates (or for the unemployment rate to move to 4.1% or 4.2% as previously mentioned). Certainly, even before we hit these targets, when we see economic data moving in the right direction (i.e., some weakness in the economy or better inflation numbers), interest rates will likely move lower as investors front-run Fed Funds rate cuts – just like they did with last Friday’s bond-friendly payroll report.
Next week, we will receive new inflation data - Producer Prices (PPI) on Tuesday, May 14 and CPI (Consumer Prices) on Wednesday, May 15. The Wall Street consensus estimate for the Core CPI (without the more volatile food and energy prices) is 3.7% year-over-year and 0.3% for the month of April. Recall, back on April 10th, the Core CPI for March posted a +0.4% increase.
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