The bond market sent a strong message last Friday: inflation is more important than jobs. Indeed, although headline nonfarm payrolls surprised sharply to the downside, 10-year yields rose roughly four basis points, closing near their 200-day moving average at 1.33%. A sharp rise in wages drove yields higher. Average hourly earnings rose by a whopping 0.6% in August, adding to a sequence of strong wage data since April, putting at risk the “transitory” inflation narrative of the Federal Reserve.
However, the yield move was still within 10-year yields’ monthly standard deviation, suggesting that the market remains dependent on the Fed's tapering plan before the yield curve steepens sharply. Indeed, the central bank continues to focus on jobs to reach pre-pandemic employment levels before withdrawing support. Thus the market expects tapering not to be announced at this month’s FOMC meeting and postponed later this year.
It's is bad news for the Bond market because it leaves bonds vulnerable to inflation numbers, US Treasury supply and more aggressive tapering.
This week’s focus will be the sale of 3-, 10- and 30-year US Treasuries. It will be critical to monitor indirect bidders participation, which is a key support to bonds' valuations. Because US Treasuries still offer a compelling yield compared to peers, we expect demand to continue to be solid. Yet, we might see a shift of investors preference from longer maturity to shorter as soon a bear-steepener will resume amid a Fed's tapering.
The Beige Book might also add to the vulnerability of US Treasuries this week as the market will want to gain a better insight concerning supply chain issues and labor market trends, which contributed to higher inflation this year. Any element that will point to more persistent inflation could spark a selloff in bonds. Yet, volatility will continue to be contained until Powell will not deliver on tapering.