Bond Traders May Have to Believe in Wage Growth

(Bloomberg Opinion) -- Talk about an unexpected U.S. jobs day for bond traders.

Some strategists were priming their audience for disappointment Friday morning, noting that August jobs data has missed forecasts almost every year over the past two decades. That didn’t happen this time around: Nonfarm payrolls rose 201,000 last month, beating the 190,000 median estimate of analysts surveyed by Bloomberg and crushing the even more pessimistic “whisper number” of 176,000.

Most surprising — and important — wages grew at the fastest pace since the end of the recession. It’s the long-awaited indicator for Federal Reserve officials to feel confident that the U.S. labor market is functioning as it should with unemployment near the lowest since the 1960s.

Bond Traders May Have to Believe in Wage Growth
Judging by the market’s reaction, traders are rushing to recalibrate their outlooks. Two-year Treasury yields surged by the most since May to set a fresh 10-year high. Eurodollar futures contracts consider a rate hike this month a lock and are now starting to lean that way about a December boost, too. Just as the idea of a Fed “pause” in 2019 was gaining momentum, including from BlackRock Inc., the central bank is suddenly in play again next year. A fed funds rate above 3 percent by year-end 2019 is no longer just for the dot plot.

Of course, even with Friday’s surge, the benchmark 10-year Treasury yield remains in a range below 3 percent, on pace for its quietest quarter since 1965. The 30-year yield is moving sideways, too. That raises the question: How soon will New York Fed President John Williams’s assertion that the central bank shouldn’t be afraid to invert the yield curve be put to the test? In the wake of the jobs data, the spread between five- and 30-year Treasuries tumbled by the most since mid-June.

In that context, does the market really see further wage growth and an acceleration in inflation? Maybe not entirely. Other factors are at play in keeping long-term rates suppressed.

But maybe it’s time to believe, with average hourly earnings rising 2.9 percent from a year earlier. Here’s MUFG’s Chris Rupkey:  

“The tight labor market is engendering more wages just like the economics textbooks proclaim and this can mean only one thing. Rate hikes are coming from the Federal Reserve, possibly at a quickened pace, where rates are going to normal levels and even higher … It is the law of supply and demand facing the steep wall of full employment, where companies if they are going to get over that wall, need to boost the rewards for their new hires or they will come away empty handed.”

This has been the missing ingredient for the Fed, even during this period of persistent gradual rate hikes. Though Jerome Powell has been considered more pragmatic than his predecessors, the mystery of wage growth has clearly been gnawing at policy makers, who themselves acknowledge that the U.S. is beyond full employment. It created some doubt as to what should be considered neutral monetary policy, and at what point does it become restrictive.

Boston Fed President Eric Rosengren, referring to the benchmark interest rate, told CNBC just before the jobs data came out that “The only reason we shouldn’t move it up more quickly is because we don’t have that much inflationary pressure at this point.”

Friday’s report signals those times might be changing. Bond traders would be wise to position accordingly.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.

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