Pivotal Payrolls
Payrolls, Policy & Treasury Supply, Immigration, Churn & Wage Growth, Abundant Evidence of Weaker Labor Demand, Except for the Most Widely Watched Number
Quadrilemma Crunch Time
The second quarter is off to a painful start for Treasury investors, 3s, 5s, 10s and 30s were all trading at new ‘24 yield highs on Wednesday morning following the marginally stronger than expected March ADP Employment report. The nominal and real (TIPS) curves steepened, similar to the August-October supply driven bear steepening. There are two drivers of the ‘real bear steepening’; firm economic data beginning with the first 50+ ISM manufacturing report since September ‘22, and a stable JOLTS report and the afore mentioned ADP report. It would be an oversimplification to attribute the selloff in Treasuries to entirely expectations of stronger growth, of the 12bp increase in 10s on Monday, 8 occurred prior to the ISM report. If we had a nickel for every time a guest on financial television said it is better for equities if there are no rate cuts in ‘24, we’d use the considerable proceeds to buy Treasury, Russell 2000 and KRE (regional bank ETF) puts. Let’s be very clear about aggregate economic conditions, monetary policy is tight for the leverage dependent parts of the economy and the pressure will intensify the longer the curve is inverted, however, fiscal policy is exceptionally accommodative, 7% deficits in an expansion are unprecedented. Consequently, the parts of the economy benefiting from record levels of government spending relative to the size of the economy are booming. Inflation is always and everywhere a monetary and fiscal phenomenon.
Underlying the pressure on USTs is Treasury supply, after two quarters of heavy bill issuance, the supply of bills is set to shrink and coupon supply increase, and even with the Fed likely to slow the pace of QT, they are unlikely to reduce the cap on mortgage paydowns. In other words, reducing the cap on maturing Treasuries will have no impact on the supply of duration (longer maturity Treasuries and mortgage-backed securities). In short, the timing of the first rate cut and more importantly, disinversion or normalization of the Treasury curve, is crucial to the participation of the banking system in absorbing the $519 billion increase in the supply of Treasury coupon securities. Inflation matters, but as we detailed in our March FOMC note, Itching to Ease, a softer labor market is the most probable catalyst for yield curve disinversion driven by Fed rate cuts.
The Bloomberg consensus is for a deceleration to a 214,000 increase in nonfarm payrolls from the 3-month average of 264,000, an uptick in average hourly earnings to 0.3% from the 0.1% February increase, back to the 3 and 6-month monthly average 0.3% increase, and a 0.1% drop in the unemployment rate to 3.8%. In our view, if the consensus proves correct, the probability of 10s above 4.5% and 10-year TIPS above 2.25%, leading to a risk-off cross asset class correction, will increase significantly. The markets need softer data to absorb Treasury supply, but the data we received since the last employment report has been mixed. The March employment report, like the CPI report on the 10th, is a test of the thesis that seasonal adjustment factors boosted the early ‘24 reports. Yes, the Fed is itching to ease, but inflation and employment need to cool back to 2H23 trends to open the door to yield curve normalization. Let’s dig into the details.