May 6, 2005
SEEING IS BELIEVING
The bond market's been reluctant to see the world through Fed-colored glasses of late, which is to say glasses that see monetary tightening as salvation from encroaching inflation. But after today's jobs report for April, the fixed-income set is starting to focus on the world as seen by the central bank.
A dramatically stronger-than-expected rise in nonfarm payrolls has the power to move otherwise immovable perceptions. The dismal scientists were calling for something on the order of a gain of 175,000 in nonfarm employment for April; the actual number rolled in materially higher at 274,000, reports the Labor Department. That's in the upper range for monthly gains in recent years.
There's more than just a strong number here. The payroll gain for April raises fresh questions about whether the weaker-than-expected first-quarter GDP report was a fluke. Indeed, the bond market took no small measure of confidence last month from the news that the economy rose at 3.1% during January through March of this year as opposed to the 3.8% logged in the previous quarter. The bond ghouls, of course, live for weak economies since that drives up the prices of bonds, which in turns drives yields down. That, in short, is nirvana in fixed-income land.
But nirvana for fixed-income traders has been put on hold. How long is anyone's guess, but optimism took a breather today. Accordingly, the yield on the benchmark 10-year Treasury shot higher, closing out the session at roughly 4.26%, the highest since April 26. Some discouraged bond investors even started mumbling that 1Q GDP revision scheduled for release on May 26 may be headed back up close to 4%.
Meanwhile, another observer captured the spirit of the day in an interview with Reuters, suggesting in so many words that yesterday's assumptions once again are destined for the circular file. "So much for soft spots, unless you think it is possible to create 700,000 jobs in the past three months and not have a solid economy," economist Joel Naroff of Naroff Economic Advisors said.
But with employment momentum rolling along, the question of what that means for inflation, and the Fed's next FOMC meeting on June 30, is back to center stage. The bond market understands that—once again, as does Kurt Brunner, a money manager with the Swarthmore Group in West Chester, Pa. "We like to see job growth, but now questions about inflation are going to be more front and center,'' he told Bloomberg News today. The Fed will "continue to tighten a little bit so that may mean it's still kind of a difficult road for stocks."
Perhaps, although by the standard of today's action in stocks Mr. Market's not quite sure what to make of the muscular employment picture in April. Indeed, the S&P 500 slipped ever so slightly today while the Nasdaq Composite inched higher.
But move on to where? Junk bonds, perhaps, which were clearly unimpressed with today's jobs report. The yield on the KDP High Yield Index rose by the smallest of margins on Friday, adding one basis point to 7.63%. The 337-basis-point spread over the 10-year, as a result, remains largely unchanged, albeit after rising sharply over the last two months from around 200 basis points in mid-March.
Indeed, the widening spread was the byproduct of the elevation in the KDP yield and the decline in the 10-year Treasury's yield. Did junk know something that Treasury traders didn't? If so, does today's calm reaction in the high-yield market signal that the storm in government bonds is over?
Definitive answers remain elusive in the here and now, but fresh clues for making slightly more educated guesses are just around the corner. That includes next week's trade balance report for March, one of the searing numbers of late among economic releases. When we last visited with this variable, the U.S. was in the red on international trade to the tune of -$61.036 billion for February—an all-time monthly low.
The dollar, it seems, is expecting something more favorable when the trade balance report hits the streets on Monday. Indeed, the U.S. Dollar Index jumped sharply today, putting the gauge within shouting distance of its 2005's highs. Of course, the dollar's strength of late is also a reaction to rising interest rates generally, including the fact that Fed funds at 3% represents a sizable premium in recent history relative to the equivalent 2% rate for the European Central Bank. And then there's today's impressive jobs report for April, which no doubt inspired more than a few dollar bulls too.
The dollar's strength, in short, is now being fueled by rising interest rates and a strong jobs reports. How long can such trends last? Good question, although an even more pressing one might unfold as follows: What are the investment implications if that combo does in fact persist? Jay Suskind, head trader at Ryan Beck & Co., was thinking along those lines when he bared his financial soul today to AP via BusinessWeek:
"Today's report comes in, it surprises to the upside, and now the thought isn't about an economic soft patch. Now, we're thinking about interest rates, and that puts the Federal Reserve back in play. We've got oil higher, and we're fearful of the Fed dampening the party. So you got good news today, but it comes with drawbacks."
Posted by jp at May 6, 2005 5:27 PM
Is the Economy Growing at 6%?
"Do you believe the economy is growing at a 6% annual rate right now?" he asks rhetorically. "Because if you don't, in my view, there is no way you can believe the strength in today's nonfarm payroll report."
Posted by: rtalcott at May 7, 2005 1:48 PM
Ok..but what is the quality of all these jobs? Are they mostly WalMart? Government? Jobs that may depend on the housing bubble? Are they minimum wage? Benefits?
I persoanlly don't se much good happening out there and I don't know AnNYONE who does either. This is more fun with numbers...like what does the unemployment figure really mean?
Posted by: rtalcott at May 6, 2005 7:43 PM