Bond investors are worrying about the possibility that inflation could rebound again, given a U.S. labor market that’s showing no signs of breaking.
Thursday’s data reaffirmed this view, with first-time jobless benefit claims dropping to a two-month low of 228,000 last week. One- through 30-year Treasury yields rose after the report and traders nudged up the chances of a post-July interest rate hike by the Federal Reserve before year-end. The Treasury yield curve, often seen as a reliable harbinger of approaching U.S. recessions, remained deeply inverted.
Ongoing strength in the labor market is translating into expectations that the Fed might have to keep raising interest rates, which in turn could boost the likelihood of a U.S. recession, analysts said.
Lawrence Gillum, the Charlotte, N.C.-based chief fixed income strategist at LPL Financial, said his firm’s base-case view is that the U.S. is likely to be heading into a mild recession toward the end of the year. Many others in financial markets, however, have recently been hopeful that the world’s largest economy can avoid a downturn and that inflation can fade without a meaningful uptick in the unemployment rate, which stood at 3.6% as of June.
As of Thursday, “the bond market is looking at the strong labor market and the potential for continued inflation pressures,” Gillum said via phone. “The concern is that, even though inflation is heading in the right direction, it could reverse” as the result of strong wage gains and continued demand.
With the Federal Reserve widely expected to raise its interest-rate target again next Wednesday by a quarter of a percentage point to 5.25%-5.5%, Thursday’s data raises the possibility that policy makers could be a “little more hawkish” in their post-meeting statement, Gillum said.
The Fed’s annual symposium in Jackson Hole, Wyo., in August also offers Fed Chairman Jerome Powell the chance to “reiterate a higher-for-longer narrative on rates” until inflation is on a consistent, sustainable path to 2%, he said.
Wall Street investors have been grappling with how the last mile of inflation could play out. The headline inflation rate, based on the latest update to the consumer-price index, decelerated to 3% in June on an annual basis from 4% in the prior month. That’s down from a 9.1% peak last summer, but it’s taken five full percentage points of rate hikes to get to this point.
Thursday’s jump in yields occurred as fed funds traders priced in a 28.6% chance that the Fed could lift its main interest-rate target to 5.5%-5.75% by November, after factoring in a July rate hike. Meanwhile, the spread between 2-
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and 10-year yields
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ended the New York session at minus 98.4 basis points. U.S. stocks
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closed mostly lower.
“Jobless claims provide a very timely snapshot of the labor market and what we’ve been waiting for is an adjustment up in claims and for layoffs to start rising,” said Rubeela Farooqi, the Jersey City, New Jersey-based chief U.S. economist for High Frequency Economics. “But businesses are not responding and that has big implications for the Fed.”
Via phone, she said, that “the Fed is looking for the labor market to soften and doesn’t have much confidence on where inflation is going. The risk is that they [policy makers] may keep hiking rates until we see some very substantial softening in labor markets — raising the risk of a recession.”
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