Bloomberg
(Bloomberg) — Bond investors, who have been focused on inflation since the Iran war began, say a surprise in the monthly US jobs report has the potential to upend their expectations for Federal Reserve interest-rate cuts.
Strategists at PGIM Fixed Income, Natixis and Amerivet Securities are on watch for February payrolls significantly above or below expectations. That could shift the focus back to the labor outlook even as rising oil prices tied to the Middle East conflict weigh on the market.
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Treasuries sold off this week on concern that the recent shock to energy markets could spill over and drive inflation higher. Two-year yields — the maturity most closely tied to expectations for Federal Reserve policy — jumped to their highest level in more than a month, and traders slashed bets on rate cuts this year.
“If jobs are being destroyed, the Fed may go back to taking some risks” and cut rates, said Robert Tipp, head of global bonds at PGIM.
A weak reading has the potential to help firm up bets on a second rate cut this year, sparking gains in the $31 trillion Treasury market. On the flip side, a stronger-than-expected report would likely further dampen the outlook for Fed easing, pushing yields higher.
“Global rates are reacting to energy around the Iranian situation. If we get a better number tomorrow it fuels the fire,” said Gregory Faranello, head of US rates at Amerivet Securities.
Investors have been ping-ponging between inflation fears tied to rising oil prices, resilience in economic growth and longer-term questions about whether artificial intelligence will ultimately boost productivity or begin eroding employment. With Treasury yields hovering in a range — benchmark 10-year notes rose to 4.17% this week — the jobs data, followed by next week’s consumer price index report, could help provide the market with clearer direction.
“The Fed is more focused on the inflation side of their mandate at the moment,” said Anders Persson, CIO and head of global fixed income at Nuveen. “As there’s so much anxiety about AI, the market will look for any sign of sectors being impacted in the jobs report.”
Ahead of the report, traders in options linked to the Secured Overnight Financing Rate had pivoted toward trades that would pay off if the Fed cuts just once this year. Previously, activity had centered on bets on a deeper and longer easing cycle.
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Two Fed officials this week said the US-Israeli attacks on Iran pose fresh uncertainty for policymakers, especially if energy prices remain elevated. Inflation has remained stubbornly above the Fed’s 2% target, with policymakers’ preferred gauge closing out last year at 2.9%.
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“Real rates have borne the brunt of the aggregate rise in yields across much of the curve. Looking at one year inflation swaps, you’d be hard-pressed to point the spot at which a conflict in the Middle East erupted, especially one that threatens a significant choke point to global oil flows.”
— Cameron Crise, Macro Strategist, Markets Live. For the full analysis, click here.
Economists expect the jobs report, set to be released Friday morning in New York, to show 55,000 jobs were created in February, down from 130,000 the prior month. The unemployment rate, which ticked down to 4.3% in January, is forecast to hold steady.
ADP Research data for February and applications for unemployment benefits last week added to evidence of stability.
So far, the market is pricing in only a slim chance that a deteriorating labor market pushes the Fed back into rate-cutting mode, said Vail Hartman, a strategist at BMO Capital Markets.
“It would take a substantial disappointment on Friday to derail the collective sense that employment conditions are stabilizing,” Hartman said.
Strategists at JPMorgan Chase & Co. recommended taking profit on tactical shorts in two-year Treasuries, saying there’s little further room for yields to keep climbing.
For investors weighing inflation risks against growth resilience, a downside surprise could point to deeper cracks in the economy.
“A soft labor market is the Achilles heel of the economy,” said John Brady, managing director at RJ O’brien and Associates LLC.
Treasuries had been rallying until the war broke out, with the market gaining 1.8% in February in its best monthly performance in a year.
–With assistance from Kristine Aquino.
(Updates price in seventhparagraph.)
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