Bond Market Throws a Head Fake

Entering a week that was chock full of economic data, it was widely expected that today’s Payrolls report would be the main event.  But as it turned out, the unheralded opening act and an unheralded closer stole the market’s thunder.

 Earlier this week, we noted:

…many of us were looking past today’s [Tuesday’s] reports on Consumer Confidence and JOLTS Job Openings toward the GDP, PCE Core Deflator, and Nonfarm Payrolls reports due later this week.  But today’s reports proved to be quite surprising, and hence market-moving, on their own.

The sharp, unanticipated drop in JOLTS proved to be an important catalyst for lower bond yields, a weaker dollar, and a 1.5% jump in the S&P 500 (SPX) on Tuesday.  In a popular vacation week, when volumes are typically light, modest catalysts can result in outsized moves.

The Nonfarm Payrolls report seemed to fit with the current karma.  Investors enjoyed seeing that the labor market seemed to be coming into better balance on Tuesday, and the slightly weaker GDP revision on Wednesday, and in-line PCE Core Deflator yesterday did nothing to change that mood.  Traders certainly didn’t mind that although the 187,000 August Nonfarm Payrolls were above the 170k estimate, it was more than offset by -30k revision to July’s number.  The big surprise was in the Unemployment Rate rising to 3.8% when no change from last month’s 3.5% was expected.  That was largely the result of an increase in labor force participation from 62.6% to 62.8%.  Those looking for another sign that labor cost pressures are easing had more reason to be heartened.

Bond prices were off to the races.  Yields on 2-Year Treasury Notes plunged 10 basis points and 10-Year yields fell by 5 bp in the immediate aftermath of the report.  Stock futures traded higher, and SPX opened about 0.6% higher. 

To be fair, it seemed as though traders were already anticipating a good report.  We were set up for a continuation of the week’s positive trends even before the data was released.  ES futures were up about 1/3% and 2-year yields were 3bp lower even before the statistics were released.  A continuation of the good mood seemed inevitable.

But just as a seemingly minor number set the market on a positive course on Tuesday, the overlooked August ISM report turned bonds, and eventually stocks, around.  The Prices Paid component rose unexpectedly to 48.4 from an expected 44, which itself was above last month’s 42.6.  The Employment component rose to 48.5 from 44.  This conflicted with the quiescent mood regarding labor, and rising inflation is certainly nothing for stocks or bonds to celebrate.

The bond market pulled a nearly complete 180.  The chart below shows how both 2- and 10- year yields more than erased their early gains and are now above yesterday’s levels:

1-Day Chart, 2-Year (white) and 10-Year (blue) Yields

Source: Bloomberg

That said, both key yields are remain lower for the week:

1-Day Chart, 2-Year (white) and 10-Year (blue) Yields

Source: Bloomberg 

As we write this, stocks are roughly unchanged on the day, and VIX declining to 13.12 shows that with this week’s numbers behind us and a long weekend ahead of us, traders are still not in search of volatility protection at the start of a typically rocky September.   We’ll know over the coming weeks if that sanguine attitude proves correct.