Great jobs data, bad news for bonds

Non-farm payrolls rose by 256,000 in December, a heavy blow to bond investors betting on quick rate cuts from the Federal Reserve. Hiring held up in healthcare, government and professional services, a sign that financial conditions are still too loose to create real slack in the economy. For bond desks, strong data has stopped being good news and become a costly risk to their duration positions.

A surprise against a cutting Fed

The number matters because of what came before it. The Fed cut its policy rate by a full percentage point between September and December, on the view that the labour market was cooling and inflation was close enough to target. In December it signalled only two cuts for this year, down from four in its September projections. The unemployment rate fell to 4.1 per cent in the latest report, which undercuts the argument that the labour market needs support.

Pay keeps rising

Where the jobs came from matters. Service-sector inflation at home is proving sticky, and average hourly earnings are still rising at a healthy clip for this stage of the cycle, which stops unit labour costs from settling at a level consistent with the Fed’s target. When employers keep hiring everyone available, consumers keep spending, and companies feel confident enough to protect their margins by passing on higher costs.

The chain from payrolls to prices runs through household income. More jobs and steady wage gains lift total pay, which supports spending on services such as travel, dining and healthcare, where labour is the main cost. Firms facing that demand have little reason to hold prices down, and service inflation feeds back into wage demands the following year. A monetary policy that is only mildly restrictive does little to break that loop while hiring runs this strong.

Yields jump

Treasury yields rose across the curve as futures traders cut the odds of an early rate cut. Two-year notes sold off hard as traders priced rates staying higher for longer, and ten-year yields took on a bigger term premium. The ten-year yield climbed to its highest level since late 2023. The dollar strengthened with it, which tightens conditions for foreign borrowers with dollar debts.

The losers from higher yields are easy to name. Mortgage rates have climbed back towards 7 per cent, which keeps existing homeowners from moving and holds down housebuilding, and companies that need to refinance cheap pandemic-era debt face higher coupons. Small companies, which borrow more at floating rates, suffer more than large ones with long-dated bonds. Savers in money-market funds are the clearest winners, since the yield on cash will stay above 4 per cent for as long as the Fed holds.

Why good news hurts

The statistical point is about which risks dominate. When inflation is well anchored, strong data mostly signals higher profits, and stocks and bonds can rally together. When inflation is the main worry, strong data signals tighter policy, and the correlation between stocks and bonds turns positive, so both fall at once. That is the regime markets have been in since 2022, and it removes the hedge that long bonds used to provide to balanced portfolios.

The market’s sensitivity to each payroll report has also risen. When the Fed says its decisions depend on the data, every release carries more information about the path of rates, and the reaction in two-year yields to a given surprise grows accordingly. A single strong month therefore shifts the whole expected path of policy, not only the next meeting. That amplification works in both directions, which is why a weak report in the spring could reverse much of this week’s move just as quickly.

Precedent from 1994

The closest comparison is 1994, when a run of strong data persuaded the Fed to tighten far faster than bond investors expected and long yields rose sharply through the year. The lesson then was that duration positions built on a benign view of the cycle can unwind very quickly; the Fed doubled its policy rate from 3 per cent to 6 per cent within a year, and Orange County’s bankruptcy in December 1994 became the emblem of the losses. The situation now differs in one important way: the Fed is not raising rates, only declining to cut them. The pain for bondholders is therefore more likely to come as a steady grind higher in term premiums than as a sudden crash.

The case for patience

There are reasons to doubt a single report. Payroll figures are revised, sometimes heavily, and the autumn numbers were distorted by hurricanes and a strike at Boeing. Productivity has grown strongly over the past year, which allows wages to rise faster without pushing up unit labour costs, and higher immigration has lifted the number of jobs the economy can add each month without overheating. If those forces hold, today’s strength may prove less inflationary than bond markets fear. A fair reading is that the data do not force the Fed to raise rates, but they remove any reason to hurry.

What to watch

The next tests are December consumer prices, due next week, and the Fed’s meeting at the end of January, where no change is expected. A benign inflation print would take some pressure off the long end, while another firm core reading would confirm the shift in regime. As long as hiring stays this strong, bond investors will keep treating good economic news as bad news for them, and the Fed will probably keep rates on hold through the spring. Holders of long Treasuries should expect ten-year yields to stay above their autumn levels until a weaker jobs report arrives.