September Jobs Report Triggers Shift in Interest Rate Outlook
BACKDROP OF SEPTEMBER FEDERAL RESERVE MEETING
After consecutive months of weaker jobs data, the Federal Reserve reduced its benchmark interest rate for the first time this interest rate cycle by 0.50% in. The takeaway from this was the Federal Reserve is relatively satisfied with their progress on inflation and is now more focused on the other half of their duel mandate: unemployment. The yield curve steepened significantly as traders began to price in a significant number of rate reductions as shorter bonds are more directly impacted by monetary policy than bonds further out along the yield curve. At the beginning of the month of September, the 2 YR and 10 YR Treasury were both trading at yields of approximately 3.90%. After the Fed meeting and at the close of September, the 2 YR and 10 YR Treasury were at approximately 3.64% and 3.78% respectively.
JOBS RELEASE OVERVIEW
The US Employees on Nonfarm Payrolls came in at 254k, far above the median estimate of economists of approximately 150k. Upward revisions to the prior two months of relatively weaker jobs numbers reinforced the strength of this report.
- Leading up to the report, traders had anticipated up to 5 rate reductions by the end of 2024 with two in hand from the September meeting; one interest rate hike/cut is thought of as a move 0.25% by the market. This would have resulted in one more 0.50% cut and a 0.25% cut at the November and December meeting. The strength of the September jobs number has resulted in volatility within the bond market as traders are reassessing expectations for cuts that align more closely with what the Federal Reserve, themselves, anticipates according to their latest Summary of Economic Projections release. As I write this, traders now expect closer to two additional cuts (0.25% each) by the end of the year.
- Yields have backed-up as a result of traders recalibrating their expectations for monetary policy. The 2 YR Treasury in particular has sold off and is now at a yield of approximately 4.00%. The 10 YR Treasury has also increased to that 4.00% threshold as the economy continues to look like its on solid footing, with an employment rate that has dropped to 4.05% and GDP Tracking over 2.5% for Q3, 2024.
- If the economy remains solid, there are a number of factors to consider. The first and foremost is that longer bond yields may already reflect the further reduction in short-term rates. It is important to remember that policy remains restrictive, even if the Fed does reduce its rate at this point. For the time being, reductions in their benchmark interest rate are equivalent to the Fed ‘easing off the brakes’ rather than ‘stepping on the gas’ as it relates to the economy. For consumers, the implications of longer rates remaining bound to their current levels is that many loans (such as 30 YR mortgages) are more tied to the 10 YR Treasury than the Federal Funds rate. For fixed income investors, the current market provides opportunity. Investors have been able to take advantage of higher yields over the last few years as interest rates began to rise coming out of 2021. A market where yields are relatively range-bound reduces reinvestment risk as bonds mature and need to be redeployed to longer-duration fixed income.
Should you have any questions about market rates in general or how we are positioning your portfolio, please do not hesitate to reach out.