The curve vs. the ratio

The arrival of another Blowout Jobs report pushed US Treasury yields higher on Friday – inverting the yield curve again.

The yield on the benchmark 10-year Treasury bond rose to 2.39 percent from 2.324 percent yesterday. The yield on 30-year bonds rose to 2.435 percent. The yield on the two-year Treasury bills rose to 2.462 percent, higher than the 10-year and 30-year bonds.

Unlike yesterday’s brief flash inversion, this one was not transient. Not only did it last all day, it intensified as the day progressed, with the gap between the twos and tens increasing.

Yields rise when bond prices fall. In this case, investors sold shorter-dated bonds in the belief that the March jobs report was all but a guarantee that the Federal Reserve would hike rates aggressively at its next meeting.

The Fed fund futures market now implies a roughly 73 percent chance that the Fed will hike rates by 50 basis points at the next May meeting, and a nearly 79 percent chance that they will hike by at least 50 basis points at the June meeting 50 basis points. Looking out a little further, there is a 36 percent chance that the overnight target will be 2.75 or higher by December.

The Labor Department said the economy added 431,000 jobs in March and that average hourly wages rose 0.4 percent from the previous month. Perhaps more importantly, the unemployment rate has fallen to 3.6 percent, just a tenth above its pre-pandemic low. The total number of unemployed fell by 318,000 to 5.952 million, around 200,000 more than before the pandemic.

Economists consider the ratio of vacancies to unemployment to be one of the best indicators of labor market tightness. With the March jobs report, that number rose to 1.9 vacancies per unemployed person. This is the highest value ever measured. Unfortunately, this ratio is also a very good indicator of inflation, as Harvard economist and former Obama administration official Jason Furman has shown. The message here is unmistakable: we have a lot more inflation ahead of us.

However, the inversion of the yield curve tells us that the Fed will likely have to cut rates over the next 18 months. Isn’t that the opposite of what the employment data imply? Are the curve and job ratio at war? We think the two can be reconciled by saying that jobs mean high inflation this year while the yield curve implies a downturn next year. So the way forward looks pretty much as if the Fed will have to hike rates even more than expected to overwhelm soaring prices. This in turn will slow the economy and perhaps send us into a recession. The Fed will then have to cut rates to try to avoid or end the downturn. The curve vs. the ratio

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