Jobs data threatens Wall Street’s recession trade

Friday’s surprisingly strong jobs data sparked a sharp rise in bond yields and a modest decline in the S&P 500, with investors reassessing popular bets that the post-pandemic economy won’t be defined by significantly higher interest rates than the one that preceded it.Yields, which rise when bond prices fall, surged after Friday’s report suggested the U.S. economy isn’t cooling quite as quickly as investors had assumed, as both job growth and wage gains significantly outpaced economists’ projections.The yield on the 10-year U.S. Treasury note settled at 2.838%, according to Tradeweb, up from 2.674% Thursday. In stocks, the Dow Jones Industrial Average edged higher, but the S&P 500 and Nasdaq Composite both fell. Still, the 10-year yield remained well below its 2022 peak near 3.5% after a large decline in July, and the S&P 500 managed a small weekly gain.Friday’s moves threatened a trade that has helped send major indexes racing higher from their recent lows. Since June 16, the S&P 500 has advanced 13%, while the tech-heavy Nasdaq has jumped 19%.Fueling that surge: Bets that inflation, which has been at a 40-year-high, will fall in the future and the Federal Reserve will walk back from its aggressive pace of interest-rate increases.“The bond market is the driver here,” said Zhiwei Ren, a portfolio manager at Penn Mutual Asset Management. “That’s a big boost for the equity market.”Mr. Ren said he has recently unwound a position that Treasury prices will fall and yields will rise because he thinks that the Fed will have to slash rates while the economy loses steam, potentially falling into a recession.The move over recent weeks has marked a return to a trend that dominated for years, even during the Covid-19 pandemic: Yields stayed relatively low and stocks continued a steady ascent, with investors spotting few other alternatives to park their cash. Tech stocks in particular flourished.Friday’s climb in yields marked the latest burst of volatility in the bond market that showed the consensus on Wall Street can quickly turn. Earlier in the week, yields also climbed after several Fed speakers underscored that additional rate increases are necessary to tame inflation.Sebastien Page, head of global multi-asset at T. Rowe Price, said he was bearish on Treasurys for much of the year in the portfolios he oversees and looked to hold less of them than the benchmarks he tracks. The firm’s asset-allocation committee has since pared that stance and is considering when to step in to buy stocks.Still, he said that the lockstep rally in stocks and bonds “feels a little bit premature.”Supporting the bond-market rally, asset managers recently increased bullish positions on Treasuries to the highest level since December 2019, according to Deutsche Bank data, though leveraged funds such as hedge funds increased their bearish bets. In mid-June, when the 10-year yield was around its peak, investors were expecting that the federal-funds rate would reach 4% next year. Interest-rate derivatives on Friday showed rates reaching between 3.5% and 3.75% by early next year, followed quickly by rate cuts.Riskier corners of financial markets have benefited from the shift. Investors piled into junk bonds in late July after six consecutive weeks of outflows, according to Deutsche Bank. The extra premium that investors demand to hold these below-investment-grade corporate bonds recently fell to the lowest level since early June, FactSet data show.And stock funds tracking companies promising fast growth in the future have attracted record inflows relative to value funds—those tracking stocks that look inexpensive relative to the market—in July, according to research firm Strategas. Investors yanked money from funds tracking commodities and energy funds.Earlier this year, many investors had placed a premium on firms that are generating high cash flow now rather than further out in the future. But JPMorgan Chase & Co. strategists expect shares of tech and growth companies to outperform other corners of the market in the near term after lagging for much of the year, in part because of the drop in yields, according to a recent note to clients.The Nasdaq Composite climbed 2.2% this week, outperforming the S&P 500’s 0.4% gain.Surprising even some investors, the decline in yields has come at the same time that the Fed has ratcheted up the pace of monetary-policy tightening, having raised short-term rates by 0.75 percentage points at both its June and July meetings.Motivating the Fed to move more quickly, inflation data has continued to come in hotter than expected. Yet investors’ inflation expectations have moved in the opposite direction, driven primarily by signs of slowing economic activity.Such expectations can be self-reinforcing. Fears that the developed world is heading quickly into a recession have already helped drive down commodity prices, which analysts expect to show up in the next round of inflation data.Although data have been mixed, some investors have also become cautiously optimistic that the pace of wage growth is slowing, reducing their concerns about a wage-price feedback loop.That assessment is hardly universal. Many investors, looking at the same wage data, have been far more pessimistic, and their concerns were buttressed by Friday’s data, which showed not only a larger-than-expected increase in average hourly earnings last month but an upward revision to June’s numbers.Should Treasury yields return to prior levels, it isn’t clear that stocks and other riskier assets would react quite as negatively as they did the first time around.When yields were rising earlier in the year, investors sold stocks not only because of how high yields were at the time but also because it was unclear how high they would need to go before they started slowing the economy, some investors said.Investors have gained “greater confidence in the ability of the Fed to contain inflation, [and] greater confidence in the idea that you won’t have to go all that high,” said Tony Crescenzi, a portfolio manager at Pimco and member of the firm’s investment committee.When the 10-year yield climbed to 3% in the spring, “it scared the heck out of investors,” he noted, but “the next time around, it could take something higher.”

Jobs data threatens Wall Street’s recession trade

Recommended For You

Subscribe to continue

Jobs data threatens Wall Street’s recession trade

Recommended For You

Wait for it…

Wait for it…

Congratulations!

Subscribe to continue