Usually, we are among the first to insist that the monthly jobs report matters not for the wild swings it can create on financial markets but for what it tells us about the state of the U.S. economy and the employment and earnings prospects of our 300 million fellow citizens.
The jobs numbers were pretty good: The nation added 195,000 positions in June, and job creation was significantly stronger than it seemed in April and May. The unemployment rate was unchanged, but more people joined the workforce. All in all, things seem to be getting better, and maybe getting better more quickly than it had seemed 24 hours ago.
It’s a pretty good report but probably not something that should cause anyone to radically overhaul their assessment of where the U.S. economy is heading. But don’t tell that to the bond market. Bonds endured an epic sell-off Friday morning, enough to drive longer-term government borrowing costs to their highest level since the summer of 2011.
At 11:45 a.m., the cost for the U.S. government to borrow money for a decade was 2.68 percent, up 0.19 percentage points over Thursday's level. That continues a runup in long-term interest rates of more than a full percentage point since May 1. In just two months, the cost of borrowed money has gone from incredibly cheap to only moderately cheap. Higher rates are translating into higher mortgage costs and higher borrowing costs for companies looking to expand, and generally should weigh against the pace of growth.
The reason for this simple math (Good jobs report = bond market sell-off = higher interest rates) is clear-cut enough. The Federal Reserve has been buying $85 billion a month in bonds since September, helping push bond and stock markets up while pushing long-term interest rates down. The better the economy looks, the sooner and faster the Fed will withdraw that help.
In one important way, the market reaction to Friday’s jobs market data is exactly what the Fed wants: financial markets taking their cues on when the Fed will end its easing programs by watching incoming economic data. The Fed will decide when and how fast to taper and end its quantitative easing strategy based on the data, in particular how rapidly the job market improves. And the market response to Friday’s jobs report shows that the message has been thoroughly internalized.
That should, in concept, make Ben Bernanke & Co. happy; better, after all, to have interest rates spike due to good jobs data than due to markets over-interpreting a stray comment from one of the 19 Fed policymakers. At the same time, the steep rise in interest rates should, and likely does, give them some pause.
Yes, it was a pretty good report, and, yes, that does on balance mean that the money supply could be tightened sooner than it had seemed on Wednesday. Not only did longer-term bond yields rise, but market also expectations for when the Fed will begin raising its short-term interest rate target, which has been near zero since 2008. On Wednesday, market prices implied a 24 percent chance that rates will have been hiked by June 2014 and a 49 percent chance by December 2014. On Wednesday those odds rose to 29 percent and 55 percent.
The direction of the move was right. But the extent of the move seemed a little overdone; it’s hard to imagine that a single good payroll number contained any real useful information about the probability of an interest rate hike 18 months from now.
We’re in a market where markets are in an all-or-nothing mindset on the future path of policy. It’s frustrating for the Fed; the central bank’s top officials spent all last week trying to insist that they’re not going to withdraw monetary stimulus quickly and indeed that short-term rates are likely to stay near zero for quite some time to come. But words are cheap. Markets are in a mode where any comment about unwinding QE, or even a single good jobs number, leads to a dramatic rethinking of the direction of future policy.
The situation isn’t entirely bad. One more promising result in Friday’s trading session was that as bonds sold off, the stock market was stable. In other words, investors were able to recognize that even if a better job market implied higher interest rates down the road, more jobs and higher incomes are also good for corporate earnings. That’s in contrast to the market sell-off the week of June 18, which battered stocks and bonds in equal measure.
The second silver lining is that there is a self-correcting mechanism at work. If higher interest rates do real damage to the economy, and particularly job growth, it will in turn push the Fed toward more easing, which will reverse some of the run-up in interest rates.
But the lesson of Friday, and the last few weeks, is this: The Fed needs to move even more cautiously when talking about its exit from the era of easy money than it may have thought. Because however nuanced the message, markets will hear the loud yell of “SELL!”