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Bond Traders Respect Job Gains, But Inflation Is Make-or-Break

If the latest U.S. payrolls report wasn’t strong enough to rattle the bond bulls, this week’s inflation data may do the trick.

Employers added an above-forecast 209,000 workers in July and the jobless rate matched a 16-year low. Bank of America Corp. said the report had “everything you could ask for” and Jefferies LLC dubbed it “rock solid!” Yet even as 10-year Treasury yields rose Friday, they still ended the week lower, as traders looked to this week’s inflation data as a better barometer of whether the Federal Reserve can hike again in 2017.

Right now they’re skeptical, with the market-implied odds of more tightening by year-end below 50 percent, in part because price growth has held stubbornly under the Fed’s 2 percent goal. Given the disappointing inflation readings in recent months, yields may rise if this week’s figure merely hits its mark, said Gennadiy Goldberg, an interest-rate strategist at TD Securities.

“The market has paid a lot more attention to inflation than in recent years, simply because that has the potential to be what changes the Fed’s mind on further rate hikes,” Goldberg said. This week’s report “has a pretty substantial amount of power to push rates to annual lows or getting us off those lows and pushing rates higher.”

The 10-year yield will start the week at 2.26 percent, about 16 basis points above its lowest level of 2017.

Traders may get some clarity on the outlook for rates from officials this week, including New York Fed President William Dudley. The market is bracing for the Fed to announce the start of its balance-sheet reduction plan in September, and the persistent job growth may also keep it on track for a gradual pace of tightening.

Parsing Signals

Neel Kashkari, the Minneapolis Fed president, has already signaled that he’s more focused on consumer price growth. He weighed in on Twitter after the jobs report, calling the data “more of the same.”

Both the consumer price index and the core figure that excludes food and energy have tumbled this year after climbing above the Fed’s 2 percent target. They likely remained below that level in July. 

The median estimate in a Bloomberg survey calls for a 0.2 percent month-over-month increase in core CPI, which would be the best since February. Here’s the thing: That’s been the estimate every month since September 2015, and it’s been too high each time since March, according to BMO Capital Markets.

As a result, traders have set the bar low for CPI.

“Job growth to me doesn’t seem to be stimulating economic growth and consumer spending like it has in prior cycles,” said Bill Gross, who manages the $2.1 billion Janus Henderson Global Unconstrained Bond Fund. “Until we see a lift back to 2 percent in terms of that core inflation rate, the Fed probably begins quantitative tightening, but won’t raise short-term rates this year.”

What to Watch

  • Until the inflation data at the end of the week, government auctions will take center stage, with Treasury selling $24 billion of three-year notes on Aug. 8, $23 billion of 10-year notes on Aug. 9 and $15 billion of 30-year bonds on Aug. 10
  • All that leads up to the release of July CPI
    • A Bloomberg survey calls for 1.8% year-over-year price growth, up from 1.6% in the prior month
    • Core CPI expected to remain unchanged at 1.7%; it reached 2.3% in January
  • Other data include consumer credit on Aug. 7, small-business optimism on Aug. 8, nonfarm productivity and unit labor costs on Aug. 9, and producer prices on Aug. 10
  • Meanwhile, Fed officials will hit the speaking circuit
    • Aug. 7: St. Louis Fed’s James Bullard speaks in Nashville and Kashkari talks near Minneapolis
    • Aug. 10: New York Fed’s Dudley to hold a press briefing
    • Aug. 11: Kashkari again in Minnesota, Dallas Fed’s Robert Kaplan speaks in Texas

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