While the blockbuster U.S. jobs report on Friday boosted risk assets, it did not lead to a significant rise in yields on government bonds.
Observers were quick to cite a host of contributing factors — including data measurement, economics and policies — but their longer-term implications for the economic and market outlook differ.
What is clear is that long-term investors face an even sharper division between a favorable short-term outlook and a medium-term one with even greater uncertainties.
Almost every element of the jobs report beat market expectations. The economy created 266,000 jobs in December, the largest monthly number since January, notwithstanding the solid employment growth that has materialized in a continued impressive jobs outperformance so late in the economic cycle. Adding in revisions to prior months’ estimates, total employment gains were 307,000, or just under twice consensus expectations.
The unemployment rate fell to a historically low 3.5%, and wage growth edged higher, though nowhere enough to signal an imminent inflation scare. Indeed, the only disappointment is the failure to attract still-sidelined workers back into employment. As such, the labor force participation rate slipped by 0.1 percentage points to a level well off historical highs.
Such a strong jobs report confirms that the U.S. household sector, and consumption in particular, will continue to power the U.S. economy. It should quiet those who warn about a recession in 2020 and embolden those who think that the economy’s domestically oriented activities will more than offset the drag from weaker global demand and trade-war concerns. With that, U.S. stocks staged a strong rally, with the three major indexes gaining from 0.9% to 1.2%.
The reaction of government bonds was more muted despite the signal of stronger-than-expected growth prospects. (And the one measure that disappointed – namely, the lower participation rate – should have also boosted yields because it suggests less slack in the labor market and, therefore, the possibility of greater wage inflation pressures in the pipeline.) Yields rose by only 2 to3 basis points across the curve; the spread between two- and 10-year notes barely moved.
Observers were quick to attribute what is a Goldilocks outcome for both the economy and markets to various reasons related to data measurement, economics and policies.
Some noted that, given how noisy the jobs data can be, one month’s number should not be a significant market mover, though they failed to explain the difference in the reactions of stocks and bonds.
Others pointed to the continued absence of significantly higher wage inflation, suggesting that, regardless of the stronger growth indicators, the Federal Reserve has one of its dual mandate reasons not to raise interest rates anytime soon. And then are those that felt that yields would be continuously contained by the likelihood of looser monetary policy over time compared with the Fed’s historic approach. Initial partial signals reinforce this.
Less cited, but also a factor, is the downward pressure on U.S. yields from the more disappointing economic data outside the U.S.
A reminder of this came earlier on Friday when a 5.3% year-over-year decline in October industrial production in Germany pointed to a worsening of the sector’s biggest contraction since 2009. This contributed to a slight widening in the U.S.-Germany yield differential, which closed trading on Friday at 226 basis points for two-year securities and 213 basis points for 10-year securities.
I suspect it is the combination of this last factor and the earlier-cited contained inflationary expectations that explains the different reactions of the equity and fixed-income markets to Friday’s job report.
Together they tilt price moves in favor of stocks, not only directly but by reinforcing the notion that an “insurance minded” Fed will remain on hold — that is, prolong the “ultra low for longer” policy — despite the stronger real economy data and the risks to financial stability down the road.
For long-term investors, the latest jobs report accentuates the challenge in reconciling short-term tailwinds with longer-term uncertainty. The latter includes, though is not limited to, whether current trade tension will give way to renewed globalization or, instead, an era of secular de-globalization; whether the further elevation of risk asset prices can ultimately be validated by economic fundamentals or, instead, be dragged down by a sluggish global economy; and what the phenomenon of “periodic illiquidity in the midst of ample overall liquidity” (to paraphrase Robert Koeningsberger) implies for the future functioning of markets.
If anything, the fallout from the jobs report made investors’ portfolio decisions that much more difficult.
Mohamed A. El-Erian is a Bloomberg Opinion columnist. He is the chief economic adviser at Allianz SE, the parent company of Pimco, where he served as CEO and co-CIO. He is president-elect of Queens' College, Cambridge, senior adviser at Gramercy and professor of practice at Wharton. His books include "The Only Game in Town" and "When Markets Collide."
© Copyright 2022 Bloomberg L.P. All Rights Reserved.