Reflation Trade Is Renewed as Jobs Data Unleash Rate Hike Bets

The global reflation trade that fueled the biggest Treasury losses in decades got a boost from stronger-than-expected U.S. jobs data, causing the market to price in an earlier start to Federal Reserve rate increases.

In a holiday-shortened session Friday, the 10-year Treasury note’s yield climbed as much as 6 basis points to 1.73% before retreating to end around 1.72%. Shorter-maturity securities more closely linked to monetary policy expectations fared even worse, with the five-year note’s yield rising nearly 8 basis points to 0.979%, the highest level since February 2020. The two-year yield approached 0.19%, last seen in June.

“Rates will continue to move higher and should because job creation is coming to fruition as the economic reopening gains speed,” said Robert Daly, director of fixed income for Glenmede Investment Management in Philadelphia. “The 5-year and 7-year sectors are the most vulnerable,” and shorter-maturity yields “should start to move higher as well.”

Market reaction to the data was initially muted, but gathered pace over the course of the session, with two- and five-year yields near session highs at the 12 p.m. New York time close. With European bond markets and U.S. stocks closed for Good Friday -- and bonds open only because of the economic data -- the extent to which the price action was exaggerated by sub-par liquidity remained unclear.

Strategists at TD Securities recommended buying 5-year notes, which at yields above 0.93% overprice the risk of a Fed rate increase, they said. It implies an expectation that the Fed will raise rates in January 2023, whereas they expect a rate increase in September 2024 as the central bank will likely complete tapering its asset purchases first, a process likely to take nearly a year.

With intermediate maturities under the most pressure, the widely watched 5-year to 30-year spread flattened, falling below 142 basis points for the first time since March 9.

Fed Chairman Jerome Powell speaks on Thursday next week, and minutes of the most recent Fed meeting are due to be released Wednesday. The week also includes the release of purchasing managers’ indexes for the services sector, a key gauge of how the economy is recovering from the pandemic.

“I’d characterize it as a knee-jerk reaction to a strong headline number that will probably fade,” said Jim Caron, a bond portfolio manager at Morgan Stanley Investment Management. “It’s baked into the cake that we’re going to get about a million jobs a month for the next several months,” but with total employment still far below pre-pandemic levels, the March results are unlikely to alter the course of monetary policy.

The impact of the most recent fiscal stimulus measures, the progress of the U.S. administration’s multi-trillion dollar infrastructure plans and the sustainability of increased inflation expectations will also be key to whether the Treasury selloff endures or extends.

Treasury futures volumes surged immediately following the jobs report, although the market took some time to find a firm direction, with the 10-year yield fluctuating between small advances and declines before pushing upward.

The labor-market data showed an increase of 916,000 in U.S. non-farm payrolls, above the average estimate of 660,000. February figures were also revised up, while the unemployment rate dropped to 6%.

What to Watch

  • Economic calendar:
    • April 5: Markit purchasing managers index for services; ISM services gauge; factory, durable goods and capital goods orders
    • April 6: JOLTS job openings
    • April 7 MBA mortgage applications; trade balance; Federal Open Market Committee minutes; consumer credit
    • April 8: Weekly jobless claims; Langer consumer comfort gauge
    • April 9: Producer prices index; wholesale inventories and trade sales
  • Fed calendar:
    • April 7: Chicago Fed’s Charles Evans; Dallas Fed’s Robert Kaplan; Richmond Fed’s Thomas Barkin; FOMC minutes
    • April 8: St. Louis Fed’s James Bullard; Fed Chairman Jerome Powell speaks about global economy on IMF panel
    • April 9: Kaplan appears in two separate Q&A sessions
  • Auction schedule:
    • April 5: 13-, 26-week bills
    • April 6: 42-day cash management bill
    • April 8: 4-, 8-week bills

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