Trading Desk Talk

Top Line

• Labor market lights up at critical moment
• Government averts a debt-limit debacle

Employment Lights up as Fed Officials Go Dark

Labor market data showed few signs of slowing last week, as the trio of the Job Opening and Labor Turnover Survey (JOLTS) report, ADP Employment Report, and Non-Farm Payrolls (NFP) all came in hotter than expected. The headline JOLTS number for April, which tracks the number of job openings left unfilled in the month, rose to 10.1 million from an upwardly revised 9.59 million in March. The employment report from ADP showed 278,000 positions were added to the economy in May—lower than April’s 291,000 figure, but significantly higher than the 170,000 estimate. And finally, NFP indicated that 339,000 jobs were added to the economy, blowing away estimates of 195,000. This comes on the heels of a stellar report in April where an upwardly-revised 294,000 jobs were added to the economy. The jobs report also contained data on the unemployment rate, which increased to 3.7% versus 3.4% in April, and average hourly earnings, which dropped from 4.4% to 4.3% year-over-year. This strength in the labor market puts the Federal Reserve in a precarious position as it entered the customary pre-Federal Open Market Committee (FOMC) blackout period. Prior to the NFP release, Fed Fund futures implied around a 20% chance that the Fed would hike 25 basis points (bps) at the upcoming June 14 policymaking meeting. However, after the NFP release, the odds shifted to a 37% probability before retracing back to 28% to end the week.

Fed speakers were out in force last week in an effort to guide investors towards the “pause and assess” narrative that Fed Chair Jerome Powell laid out in a May 19 speaking engagement. Philadelphia Fed President Patrick Harker echoed this point, stating, “I think we can take a bit of a skip for a meeting and, frankly, if we’re going to go into a period where we need to do more tightening, we can do that every other meeting.” This preference for a rate hike pause, or “skip” as some strategists are saying, was also encouraged by Board of Governors member Philip Jefferson. “Indeed, skipping a rate hike at a coming meeting would allow the committee to see more data before making decisions about the extent of additional policy firming,” said Jefferson, the vice chair nominee. This comment was given more weight by markets, as the vice chair is typically seen as a vote in line with the chair. Finally, former New York Fed President and FOMC Vice Chair Bill Dudley authored an opinion piece on Bloomberg that said (i) the case for higher U.S. interest rates is compelling, (ii) the Fed, no longer woefully behind the curve, must weigh a deep economic recession against out-of-control inflation, and (iii) the labor market remains too tight and wage inflation too high—meaning any pause will probably be short-lived. All of this has set the table for an interesting two weeks, as important gauges of both economic activity (S&P Global U.S. Services PMI and ISM Services Index) and inflation (Consumer and Producer Price Indices) are set to be released before the June 14 FOMC meeting.

Debt-Limit Diffusion

A sigh of relief swept across global financial markets as months of political posturing on Capitol Hill came to an end. The Senate passed a debt-limit bill, averting a U.S. Treasury default, late last Thursday by a 63-36 vote. The bill, signed by President Biden on Friday, raises the debt limit through January 1 of 2025 and is slated to cut the federal deficit an estimated $1.5 trillion over the next decade by keeping non-defense funding essentially flat, according to the Congressional Budget Office. One aspect of the bill that is a departure from the status quo of the past three years is an August 30 sunset on the Education Department’s suspension of federal student loan payments and interest. This suspension was originally intended to act as a lifeline for those struggling to make student loan payments as COVID shut down the U.S. economy and has been in place since March 2020. Lifting this pause will affect an estimated 40 million Americans and is expected to curtail a $5 billion-per-month price tag, according to the Committee for a Responsible Federal Budget (CRFB), a nonpartisan and non-profit group that aims to educate the public about issues that have a significant fiscal policy impact. The CRFB has estimated that suspension of student loan payments adds about 20 bps to Personal Consumption Expenditures, the Fed’s preferred gauge of inflation, so this may be a signal of inflationary relief—at least to an extent. Other highlights of the debt ceiling deal include the return of around $30 billion of unspent emergency COVID funds, an increase in the work requirement age for SNAP recipients, and a streamlining of the permit process for energy projects. Treasury yields dropped as the odds of a U.S. default plummeted. After reaching a peak of over 7% last month, Treasury bills coming due in June are floating in the 4.95% to 5.09% range, with yields dropping anywhere from 4 bps to 33 bps on Friday alone. Yields on the important 10-year note also dropped from 3.80% at the end of last week to a low of 3.59% prior to the release of the May jobs report.  

From the Desk

Fannie and Ginnie Mae – The tone in the market was slightly more positive last week for both GNMA and FNMA new origination. On the GNMA side, the optimism is a bit confusing, as most investors we talked to still expressed concern with the upcoming FDIC Project Loan (PL) portfolio as well as angst about their ability to structure and sell their REMICs. Nevertheless, bids continue to come in strong. The market here is a bit two-faced, though, in that half of the market is holding spreads firm but the other half is a bit back (at least 10 bps back from the recent auction winners). DUS spreads are holding in with a slight bias tighter week-over-week. The same story is holding with plain vanilla and full IO structures garnering the tighter execution levels and open yield-maintenance, declining-prepayment, and off-the-run structures requiring a heavy concession to clear.

Municipals – AAA tax-exempt yields were lower throughout the yield curve week-over-week, as the agreement on the debt limit calmed market participants for the time being. State and local issuers stood to have been negatively impacted if the U.S. debt rating was downgraded as a result of any default. The market saw a sixteenth straight week of municipal bond fund outflows with $1.30 billion leaving the market (year-to-date high-yield bond funds went negative for the first time with net outflows of $192 million for the year).  Primary new issuance remains lower compared to a year earlier, with volume in May 2023 down 29% compared to a year earlier due to higher interest rates. As we enter the summer months, we expect demand from investors to be strong through August as they are set to receive approximately $130 billion of principal and interest payments to reinvest.

The Week Ahead

The week ahead has little in terms of new information to move markets. This morning’s S&P Global U.S. Services PMI, Factory and Durable Goods Orders, as well as ISM Services Index, provided the bulk of the relevant data for investors to chew on. The remainder of the week holds Trade Balance, Consumer Credit, Jobless Claims, and Wholesale Trade Sales as well as Inventories.

As mentioned above, Federal Reserve officials are in their customary pre-FOMC blackout period. Though this is the case, Jerome Powell is set to testify on Capitol Hill on June 11, just three days before the conclusion of June’s FOMC meeting.

Economic Calendar

Summary of Global Fixed-Income Markets

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