Bond Yields Remain Market's Pressure Point Despite Soft US Jobs Report

What happened

The US jobs report for September, released on Friday, showed non-farm payrolls rising by just 29,000, a figure significantly below market expectations. Initially, this news provided some much-needed relief, with 10-year Treasury yields falling to a low of 5.16%. However, this reaction proved short-lived.

Yields quickly rebounded, ending the week near 5.28%. This recovery suggests that while the jobs data may have eased some pressure on the Federal Reserve's (Fed) October meeting decision, investors have not entirely abandoned the prospect of further monetary tightening.

Why it matters

The resilience of bond yields, even in the face of weaker economic data, indicates that other factors are exerting a strong influence on the fixed-income market. Market expectations regarding the Fed's policy have shifted, with the priced-in probability of a pause in interest rate hikes in October rising to around 82%. However, the possibility of a 25 basis point hike in December remains high, with approximately an 83% chance priced in.

The crucial point is that the forces driving long-end yields higher are not solely about the Fed's future decisions. Persistent fiscal deficits, heavy Treasury issuance, and a rising term premium mean investors demand greater compensation for holding longer-dated debt. This keeps the focus on Treasury yields, particularly the long end of the curve.

Market impact

• Interest rates and bonds: The persistence of upward pressure on yields, even with weak jobs data, suggests bonds could remain under stress. If yields test recent highs again, it would indicate that structural pressures are dominating, which is negative for bond prices.
• Dollar and currency: Continued strength in US bond yields could support the dollar, as it attracts foreign capital seeking higher returns. However, uncertainty surrounding the future of monetary policy and the health of the US economy could lead to volatility.
• Equities: The difficulty for bonds to find lasting relief may limit optimism in equity markets. If long-term yields continue to rise, it could act as a headwind for stock appreciation, especially for interest-rate-sensitive sectors.
• Commodities: The impact on commodities is less direct, but a stronger dollar and the possibility of slower global economic growth, reflected in bond market pressure, could weigh on some commodity prices.
• Brazil: The outlook for Brazilian assets is one of caution. Persistent high US interest rates could maintain pressure on the Brazilian Real and capital flows to emerging markets. The minutes from the Copom meeting and domestic inflation data will be crucial for the direction of the Selic rate.

What to watch

Investors will be closely watching the US September Consumer Price Index (CPI) report, due on October 14. This data will be critical in determining whether the Fed can afford to remain patient on inflation. Additionally, the US midterm elections on November 3 will bring fiscal policy and government finances into further focus.

Scenarios

Base Case: Long-term bond yields continue to grind higher due to fiscal and supply-side factors, limiting equity upside potential and keeping the dollar relatively strong. The Fed may pause hikes, but inflation prevents imminent cuts.

Risk Case: An unexpected acceleration in US inflation, indicated by the CPI, forces the Fed to signal further monetary tightening, pushing bond yields to new peaks and significantly pressuring global equities. Alternatively, a sharp increase in US fiscal deficits could trigger a more aggressive bond sell-off with ripple effects across other assets.

Original source: ForexLive (InvestingLive). For information only, not investment advice.