353,000 jobs and no March cut

Non-farm payrolls rose by 353,000 in January, far above forecasts, and December's figure was revised sharply higher. The report ended Wall Street's hopes of a Federal Reserve rate cut in March and sent government bond yields up across the curve.

What the market had priced

The disappointment was a measure of how far expectations had run. In December the Fed's own projections pencilled in three quarter-point cuts this year, and futures markets quickly priced in considerably more, with the first widely expected in March. Treasury yields fell sharply in November and December on that view, and stocks rallied to records. At its meeting on 31 January the Fed held its policy rate at 5.25 to 5.50 per cent, dropped its language about further increases, and Jerome Powell said a cut in March was unlikely. The jobs report two days later confirmed his caution.

March is off the table

Unemployment held at 3.7 per cent and average hourly earnings rose by 0.6 per cent month-on-month. The economy shows no sign of tiring. The Fed has no case for easing while employers are adding hundreds of thousands of jobs and wage growth is picking up. Investors hoping for early cuts will have to accept that the first one has probably slipped to the summer.

The revisions strengthened the message. December's gain was lifted to well over 300,000, and the annual benchmark revision published with the report raised the level of employment. Hiring was broad, with professional and business services, health care and retail all adding jobs. Wage growth over the past year rose to 4.5 per cent, a pace that is hard to square with inflation settling at the Fed's 2 per cent target unless productivity keeps growing strongly.

How the repricing works

The move in markets followed a clear chain. Two-year Treasury yields, which track expectations for the Fed over the next couple of years, jumped as traders removed the March cut and trimmed the number expected this year. Longer yields rose less, though still enough to push mortgage rates back up after their fall at the end of last year. The dollar strengthened against most major currencies, as higher American rates widen the gap with Europe and Japan. Equities initially wobbled, then held up on the view that strong growth supports corporate earnings.

Supply is less of a worry than it was in the autumn. At its quarterly refunding on 31 January, the Treasury raised the size of its longer-dated auctions once more but said it did not expect further increases for at least the next several quarters. That caps one of the forces that pushed ten-year yields close to 5 per cent in October, and it helps explain why long yields rose less than short ones on the jobs report. The repricing is about the timing of Fed cuts, not a fresh fear of a flood of bonds.

For the Fed, the calculation is about risk. Cutting too early and seeing inflation return would damage its credibility and could force it to reverse course. Waiting too long risks an unnecessary rise in unemployment. With the labour market this strong, the second risk looks remote, so there is little cost to waiting a few more months for inflation data to confirm the trend.

A 1995 template

The precedent officials may have in mind is 1995. The Fed doubled its policy rate in the year to February 1995, then held it before making its first cut in July, once it was confident that inflation was contained. The economy avoided recession and went on to grow strongly through the rest of the decade. That episode is the textbook soft landing, and it involved a pause of several months between the last increase and the first cut. By that standard, a first cut this summer, about a year after the last increase in July 2023, would not be late.

Winners and losers from delay

Savers and holders of cash are the clear winners, as money-market funds and short-dated bills continue to pay more than 5 per cent. Banks benefit from higher yields on floating-rate loans. The losers are borrowers who had hoped for relief: homebuyers facing mortgage rates well above 6 per cent, companies with floating-rate debt and commercial property owners trying to refinance. Regional banks with large exposure to office loans face a longer wait for lower funding costs, and the collapse in the share price of New York Community Bancorp last week showed how fragile some remain.

The dovish reading

The counterargument is that the January report may overstate the economy's strength. January figures are heavily seasonally adjusted and often noisy. Average weekly hours fell, possibly because of cold weather, which can inflate hourly earnings as pay is spread across fewer hours. Other indicators, such as job openings and quits, have cooled, and core inflation measured by the Fed's preferred gauge has been running below 2 per cent on a six-month annualised basis. On this view the Fed can still cut by the spring.

That argument deserves weight, and it may win out if the next few months' data soften. For now the burden of proof has shifted. The indicators to watch are the January consumer-price figures due next week, the February jobs report in early March, and the Fed's updated projections at its meeting on 19 and 20 March.

A gain of 353,000 jobs has killed the case for a March cut. Bond investors should plan for a summer start at the earliest, and for short-dated yields to stay high until then, with June the earliest meeting at which a first cut looks plausible.