The Federal Reserve might be unable to lower its benchmark lending rate until late in the autumn, market-derived data suggested Friday, as a global selloff in government bond markets suggests extended inflation pressures over the coming months.
A hotter-than-expected December jobs report, which included 256,000 new hires, most of them from the private sector, is weighing on Treasury bonds. Indications that companies are reluctant to fire workers until they have greater certainty for the prospects of the economy under President-elect Donald Trump is also contributing to the sell-off, pushing stocks firmly lower.
Benchmark 10-year Treasury note yields, which play a key role in the global financial market's definition of a risk-free rate, hit the highest levels since early spring on Friday following the December jobs report.
At around 4.77%, the 10-year yield is also likely to add upward pressure on mortgage rates, which tested the 7% threshold last week and are likely to rise further over the coming weeks. This will slow any chance of a recovery in housing until at least the spring or summer months.
Benchmark 2-year notes, meanwhile, are testing the 4.4% level as investors anticipate a "higher for longer" rate environment.
Fed Chair Jerome Powell may need to modify his view that the labor market isn't stoking inflation pressures in the world's biggest economy. ANDREW CABALLERO-REYNOLDS/AFP via Getty Images
More immediately, however, the rise in Treasury yields is hammering investor calculations for U.S. stocks, which are based in part on the so-called risk-free rate (and slump lower when rates move higher), as well as bets the Fed will reduce its benchmark lending rate over the first half of the year.
The S&P 500, in fact, ended Friday with a 1.54% decline, putting the benchmark just a few points north of where it closed on Election Day in early November.
Interest rate cuts will have to wait
"With a new Administration coming in, policies such as immigration reform, government hiring (or closures and layoffs), and incentives to spend more aggressively in places like in energy, will influence the ‘to and fro’ of job-demand in the country," said Rick Rieder chief Investment officer of global Fixed income at BlackRock.
"And furthermore, the Federal Reserve has cited, almost as a perquisite, that softness in labor conditions would have to be in place to continue to move the Fed Funds policy rate to lower levels, and we didn’t see a lot of motivation for that today," he added.
The CME Group's FedWatch tool, which tracks bets on rate changes in real-time, now pegs the first Fed interest rate cut in October. The odds of another cut by the end of this year are just 23.1%.
That could add further complexity to a market that is looking for Fed easing to justify the valuations it is assigning to stocks. By some calculations, valuations are the highest in five years. Markets are also banking on cuts to further boost the domestic economy.
This dynamic may be crucial to the President-elect's broader ambitions for tax cuts, tariffs, and an immigration overhaul. For the most part, these actions are predicated on America's ability to 'grow its way out' of a debt burden that is on pace to top $40 trillion by early next month.
Higher Treasury yields will take capital from investments that target economic growth, slow the recovery of the housing market, and drain more cash from the Treasury for debt service payments.
About that $40 trillion ...
That's likely to ignite another round of debt-ceiling debate on Capitol Hill. The current suspension ended earlier this month and the so-called "extraordinary measures" to compensate are likely to kick-in next week.
Congress, meanwhile, may find it difficult to justify a corporate tax cut, a key plank of the President-elect's economic agenda, when debt levels, servicing costs and mortgage rates are all powering higher.
"While we do not expect the US to default on its debt, we highlight that upcoming debt negotiations may be entangled with fiscal policy concerns over growing debt and deficits, ultimately slowing the pace of policymaking in 2025," said Monica Guerra, who heads US Policy at Morgan Stanley Wealth Management.
The market's focus, then, is likely to remain firmly on both the surge in Treasury yields, which is being mirrored by increases in government borrowing costs in major economies around the world, and the near-term path for inflation.
The University of Michigan's benchmark consumer sentiment survey, published Friday, showed year-ahead inflation expectations surged to 3.3% last month, the highest since June 2008.
Inflation isn't over yet
"The wobble in the stock market, slight upward creep in gas prices, and rebound in mortgage rates probably all weighed slightly on consumers’ confidence at the start of this month," said Oliver Allen, senior U.S. economist at Pantheon Macroeconomics.
"But, reading between the lines, worries about the potential impact of some of Donald Trump’s economic policies seem to be denting confidence too," he added.
Global oil prices aren't helping, either. U.S. crude has tested the highest levels since early October, nearing the $80 per barrel mark, following reports that outgoing President Joe Biden may tighten sanctions on Russia before leaving office later this month.
The Commerce Department will publish its CPI inflation estimate for the same month next week. Still, with the stronger-than-expected December jobs report, economists will likely need to recalibrate their early forecasts for a pullback in core and headline pressures.
"On the precipice of this new year and new administration, there are a whole lot of unknowns," said Elizabeth Renter, senior economist at Nerd Wallet.
"When it comes to the economy, there are the current paths we can see in the data, those that maybe aren’t clear yet, and a whole host of possibilities that have yet to be decided, let alone influence things," she added.
