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Rates traders are continuing to price in the prospects of an aggressive start to the Federal Reserve’s next rate-hike cycle in coming months, despite Friday’s release of a disappointing 199,000 jobs gain for December.
After the jobs report was released, futures reflected a 68% chance of a 25 basis point hike in March and 27% likelihood the fed funds target rate will be 50 basis points higher than it is now by the Fed’s May meeting, according to CME’s FedWatch tool. That’s not too far from where both odds stood on Thursday. Such moves would lift the fed funds rate target to between 0.25% and 0.5% in March, and to 0.5% to 0.75% in May, from zero to 0.25% currently.
Also on Friday, overnight indexed swaps were reflecting the likelihood that Fed officials deliver something more than just a single 25 basis point hike by the end of their May meeting, according to Ben Emons, managing director of global macro strategy at Medley Global Advisors in New York.
Source: Bloomberg LP
The market is attempting to envision what Emons is calling “dual” or “double” tightening by the Fed, after the central bank’s December minutes revealed on Wednesday that nearly all policy makers were interested in reducing the Fed’s more than $8 trillion balance sheet at some point, in conjunction with hiking rates. Friday’s jobs report contained enough encouraging ingredients — such as a declining unemployment rate, higher average hourly earnings and job gains in previously hard-hit sectors like leisure — to “intensify expectations for a sooner and faster tightening of Fed policy” earlier in the day, the strategist said.
Read: The U.S. jobs report is not as weak as looks for the second month in a row. Here’s why.
“The headline jobs number was a bit misleading, and there are a lot of elements in the report to suggest that the U.S. may be approaching maximum employment,” Emons said via phone. “The market is trying to work out this possibility of a double or dual tightening, and doesn’t know what the impact of a smaller balance sheet will be, so it’s extrapolating that into fed funds futures.”
“The market is pricing in a campaign of sooner and faster tightening,” he said.
Expectations for a more aggressive hiking-campaign are also being projected in real yields, which continued to rise from steeply negative levels on Friday. Interestingly, though, such expectations aren’t fully reflected nominal Treasury yields, which eventually moved higher after Friday’s jobs report.
Read: ‘Frankly, I’m surprised by how little yields moved’ since Fed minutes, with the jobs report looming
Rates in the belly and long end of the Treasury curve led the gains in yields. The 10-year yield
TMUBMUSD02Y,
rose to as high as 1.8% on Friday, adding to a roughly 24 basis point gain in the prior four trading sessions. The 30-year yield
TMUBMUSD30Y,
which was up this week by 21 basis points as of Thursday, rose to just above 2.1% as U.S. benchmark stock indexes were mixed in afternoon trading.
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On Friday, San Francisco Fed President Mary Daly said that the central bank could start to shrink its balance sheet after one or two rate hikes. Her remarks came a day after her colleague in St. Louis, James Bullard, said the first rate increase could come as soon as March. Bullard is a 2022 voter on the rate-setting Federal Open Market Committee.
