For the second month in a row the non-farm payroll and the household employment reports have diverged. The establishment survey came in at less than half of consensus expectation at 199,000 new jobs, while the household measure registered 651,000 new jobs for the month. That measure was enough to push the unemployment rate down to 3.9%, and just above the post-financial crisis low of 3.5%. That comes on the back of the surprisingly hawkish minutes of the December 15th FOMC meeting. Not only did the minutes solidly indicate a March rise in Fed Funds, the committee apparently had a meaningful discussion on the appropriate size of the Fed balance sheet under normal circumstances. That discussion included how fast they would allow a runoff of maturing securities. The minutes failed to detail a targeted amount, but it’s certainly well below the current balance of $8.2 trillion. They did indicate that a “substantial buffer” is the likely target. Also, some participants favor a complete runoff of the Fed’s mortgage-backed holdings in favor of Treasury debt. That last point could become problematic in a rising rate environment. Mortgage-backed securities are negatively convex, which is to say that as interest rates rise the duration extends. In a rising interest rate environment home owners are less likely to refinance and the pace of maturing MBS would slow, perhaps materially.
Undoubtedly, the most important economic release of the month is the jobs report on the first Friday of the month. Jobs drive the economy! The November report was a bit of a “headscratcher” though. The general public and media look to the nonfarm payrolls as the lead indicator of job gains and in November that number came in well below expectation, registering 210,000 new jobs versus an expectation of 531,000. That statistic is based on a survey of businesses.
Wednesday November 10th provided a proverbial “gut punch” to the capital markets. The day started with the inflation report for October that was way above expectations and was capped with a 30-year bond auction that was an absolute disaster. Year-over-year CPI came in at 6.2% versus the 5.4% registered last month. Fed Chairman Powell continues to believe that the uptick in inflation is going to pass but it’s not happening, and people are not happy about it.
At the September FOMC meeting Chairman Powell and the Open Market Committee failed to signal a concrete start to tapering open market purchases, but they did inch closer. Powel described current economic condition as having mostly met the committee’s standard to begin to taper and suggested that an announcement would be made at the November meeting. It was also announced that the Reverse Repo (RRP) operation designed to sop up excess front end liquidity will be doubled from $80 billion per counterparty to $160 billion. That totals over $12 trillion dollars if every counterparty maxed out the operation! The size of outstanding RRP ballooned at quarter end, totaling over $1.6 trillion, a record for the program.
August proved to be the quietest month of an unusually quiet summer. The 10-year Treasury Note had a 13 basis point range for the period. The supposed highlight of the month was to be Chairman Powell’s comments to the virtual Jackson Hole Central Bank meeting on the last Friday of the month. Despite a cadre of Central Bankers calling for an immediate halt to the open market purchases, the Chairman fell short of that mandate, saying the Open Market Committee is likely to commence tapering before the end of 2021.
The last several weeks have been typical low-volume, low volatility summer trading in both the equity and bond markets. The 10-year note yield drifted steadily lower during July, falling 24 basis points to end the month at 1.22%. Economic data confirmed that the economy continues to expand at an above trend pace and the “transitory” price hikes continue to bedevil consumers. The most anticipated event of the month was the post-FOMC press conference. Unfortunately, Chairman Powell effectively repeated his comments from the previous press conference with scant details on reversing their easy money policy. One point of clarification, however, is that he doesn’t want to begin tapering open market purchases until the unemployment rate falls closer to where it was before the COVID outbreak.
Market volatility continued in June as investors expressed relief that much of the Covid-mandated restrictions had been lifted while simultaneously worrying that the more serious Delta variation could possibly force the population back into quarantine. While the latter caused an occasional plunge in stock prices, the corrections have been short lived as long bond yields have steadily fallen, with the 30-year note below 2.00% at the time of this writing.
The big news this month was the Fed announcement that the Central Bank intends to reduce their holdings of ETF’s and individual corporate notes. Selling secondary holdings can technically be defined as tightening, but in this case the size is tiny relative to their buying operations and can be explained away as an administrative adjustment. In individual corporate names they hold over 1,200 line items and about two dozen ETF’s, both investment grade and High Yield. We don’t expect the unwind to have any market impact at all. The bigger issue is that the Street has begun to speculate that at the June 16 FOMC meeting, the Fed will raise the rate paid on Reverse Repo and IOER by 5 basis points. In doing so, the Fed would effectively reset the T-Bill to about that same level, lifting it off of the 0.00% level at which it has been trading for months. The one issue potentially keeping the Fed from acting is their continued insistence on avoiding any form of tightening – perceived or real.
After three consecutive months of rising 10-year interest rates, the benchmark note yield drifted lower in April ending the month at 1.62%. To put that into perspective, the 10-year rate bottomed last summer at 0.50%. The move higher has been driven by the easing of COVID-related restrictions, the resultant strong rebound in economic activity, excessively easy monetary policy and the concern that the fiscal stimulus passed by Washington will result in higher inflation.
The start of the second quarter has been quiet in the fixed income market, with the yield curve unchanged and a dearth of new issuance.
The March inflation measures, which was expected to be elevated, didn’t disappoint. The Producer Price Index, released Friday morning April 9th after a computer glitch at the BLS held up the report for 25 minutes, registered 4.2% YOY. Well above last month’s 2.8% reading. Traders chose to ignore the surprise though, and the bond was little changed on the day.