Treasury Yields, Jobs, Stimulus and the Markets

It has been a news-filled couple of weeks, most of which are only tangentially related to markets. However there have been two notable developments in the last week worth discussing that might have gotten lost amid all the political news: the lurch higher in 10-year Treasury yields and the Job Openings and Labor Turnover Survey (JOLTS) report. I'll also make a small comment on fiscal stimulus and what market gyrations around that could mean. Treasury Yields Close to 4-Month Highs On Monday, the 10-year Treasury closed at 0.78%, its highest level since June 9. This appears to be a breakout from a 8-week period of extremely low volatility, where almost every day the 10-year kept within a range of 0.65% to 0.70%. Treasury yields fell a bit on Tuesday after fiscal stimulus talks seemed to collapse but have almost completely reversed that in the early going on Wednesday. The reason for rates rising is pretty simple: markets are becoming more optimistic about the economy. Consider the following: Longer-term bond yields are rising more than shorter-term yields (e.g., 5-year yields are up 8 basis points since 9/28, 30-year yields are up 16 bps). The shorter the bond is, the more its yield is a reflection of near-term Fed policy, the longer it is, the more it is about long-term growth and inflation. When longer-term bonds are rising more than shorter-term bonds, it means markets expect more growth and/or more inflation. Indeed, the rise seems to be a mix of both. Inflation expectations over the next 10 years, as measured by TIPS yields have moved up by 7 bps over that same period, meaning real yields (reflecting long-term growth expectations) rose by 5 bps. There hasn't been any change in either Fed expectations or supply of Treasury bonds. In fact, if fresh fiscal stimulus negotiations have collapsed, that means less forward supply, not more. There's been some talk about whether the Federal Reserve would allow longer-term rates to keep rising. This week, Cleveland Fed President Loretta Mester suggested she'd support tilting QE toward longer-term bonds, ostensibly to have a bigger impact. However I don't think Mester's idea has much support within the Fed. I think mildly higher rates are welcomed by the Fed, especially if they reflect optimism about long-term growth and inflation. Remember, the whole point of average inflation targeting was to create more policy space, which necessitates interest rates rising. JOLTS Report Mildly Disappointing I wrote last week that Friday's payroll report was encouraging. Unfortunately, this week's Job Openings and Labor Turnover Survey (JOLTS) was a little disappointing. As I discussed, I'm watching the industry-level data closely for signs of business optimism. In particular, I'm hoping to see job openings (and hiring) increasing in sectors less impacted by the pandemic itself. These industries should be reacting more to company optimism about the economy itself, and not about Covid per se. The particular ones I think are most telling are those where employees were mostly able to work from home: finance, professional services, and information. Job openings in these sectors were flat to down in August (note, JOLTS reports on a one-month lag), leaving the combination of the three down 30,000 month over month. Openings in this group are down 3% from February levels. If this subset can regain upward momentum, it would be a great sign that unemployment will keep falling rapidly. If it doesn't, it makes it more likely that unemployment will stabilize at a higher level than pre-Covid. Another interesting note from this report is that openings fell a good bit in both the construction and healthcare sectors. Construction can be very volatile, so this might just be noise. Healthcare is a space where hiring has been rapid in recent months, not surprisingly. Some of this has been pandemic related, but also a good bit is rehiring of employees related to non-acute healthcare roles, like dental hygienists. In total, the healthcare sector now has more employees than it did in February. Hence, the decline in openings might mean these roles have been filled and healthcare won't be the driver of job recovery that it has been. Some people keyed on the small decline in the quit rate, to 2.0% from 2.1%. The idea is that if employees are willing to quit their job, they must be optimistic that they can find another job. While I agree that the quit rate is worth watching, it is silly to ascribe any meaning to a 0.1% change. The quit rate was about 2.3% for most of 2018-2019, but was between 2.0% and 2.1% from 2015-2017. As long as we're in that range, I'm not going to put any weight in fluctuations within the range. One positive note on employment was from the ISM Services survey, where the future employment index ticked above 50 (to 51.8) for the first time since the Covid crisis began. Readings above 50 indicate that on net employers plan to expand headcount. Fiscal Stimulus and Markets On Tuesday when President Donald Trump tweeted that he was shutting down negotiations over a new fiscal stimulus package, stocks plunged and Treasury bond prices soared. On Wednesday, Trump put out another tweet suggesting that the White House was working on a smaller stimulus deal, which helped stocks rebound in pre-market trading. Where this goes is anyone's guess, but this clearly shows that markets would like to see a stimulus deal get done. Of course, if current polls are to be believed, Trump won't be president for much longer, and markets could soon turn their focus to whether a President Joe Biden would be more likely to pass some sort of fiscal stimulus. I think it is safe to say that a Biden win is fully priced in, but control of the Senate is up in the air, and that likely makes a big difference as to whether a big stimulus package can get done. For what it is worth, I think markets are focused on three big things in relation to this election, in order from most important to least: A peaceful transition of power. Taxes stay low. Fiscal stimulus. As we enter this last month, polls showing Biden with a bigger lead make #1 better, #2 worse, and #3 better. How exactly the market digests the combination of these three will be interesting to watch. If the economy keeps improving, the importance of #3 may decline, and the market will focus more on #1 and #2.

Treasury Yields, Jobs, Stimulus and the Markets

While a Biden win is likely fully priced in, control of the Senate is up in the air, and that makes a big difference.

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