Forget US employment data – watch Treasury yields instead

The US economy added just 74,000 jobs in December, according to the latest non-farm payrolls data, but the unemployment rate slid to 6.7%, data released on Friday showed.

The figure missed expectations of 197,000 in a Bloomberg poll, which rattled the markets, but at the same time, the unemployment rate is getting very close to the Federal Reserve’s 6.5% level, below which it will apparently consider raising interest rates.

Pundits will be poring over the exact meaning of the figures, but despite the hype around the non-farm payrolls, it’s well known that they should be taken with a pinch of salt. They are revised every month, sometimes by a lot. So, one month’s number is largely irrelevant for the long-term investor.

Even the unemployment rate is largely irrelevant. The latest Fed minutes state that the Federal Open Market Committee now anticipates “that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6.5%”. So, not a real target, then.

In a world of constantly moving goalposts and wide data revisions, what benchmark should investors actually pay attention to?

What really matters to markets

If you want to know when US interest rates might rise, look at five- and ten-year US Treasury yields for signs that the markets are finally waking up to the realisation that ‘tapering’ does actually mean genuine monetary ‘tightening’ – in spite of what the Fed will have you believe.

Fed officials are going to great lengths to deflect attention from the fact that they slowed down the printing presses (even if only by a modest $10bn a month to $75bn) – by stressing as often as possible that they are committed to keeping interest rates at zero for a long time.

But zero rates are largely irrelevant too in the current climate, no matter how long they are maintained. If they alone had worked to revive the economy, the central bank would not have had to print money in the first place.

So make no mistake about it – tapering is tightening in today’s environment. There are signs that the market is picking up on this. Yields on five-year US Treasuries have risen from about 1.54% on 18 December when the Fed announced it would cut its asset purchases to around 1.75%.

US ten-year bond yields climbed from 2.84% on 18 December to 2.97% now, but were above 3% for three days in January already.

Watch for inflationary pressure too

The other indicator that the Fed must take care of – inflation – is behaving reasonably well. Prices rose by just 0.9% year-on-year in November – below the 2% target.

But inflationary expectations are on the increase, at least judging by the difference between yields on ten-year bonds and those on ten-year Treasury inflation-protected securities (Tips).

The difference – used as a gauge of trader expectations for consumer prices over the life of the debt – widened to 2.31 percentage points; the highest since May and compared to an average of 2.22 percentage points over the past decade, according to Bloomberg.

Meanwhile, without much fanfare, the Fed has added a new instrument to its toolbox – an overnight reverse repurchase facility – to help it fine-tune market interest rates, in a sign that it probably anticipates increased volatility as tapering begins.

Such a facility would “improve the Committee’s ability to manage short-term interest rates, regardless of the size of the Federal Reserve’s balance sheet,” says the New York Fed’s website.

In other words, the Fed has had enough of money printing, and plans to try to influence the economy via small tweaks in money markets instead.

The central bank has started its huge task of weaning the markets off the liquidity it has pumped in over the past five years. It’s doing it as gently as possible, and so far the markets have taken it in their stride.

But anything can upset such a delicate balance. So, keep your eyes on US Treasury yields – that’s where any panic will show up first.

  • Pinkers Post

    Brilliant analysis. Spot on. “Moving goalposts” appears to have become a sport in its own right. The central bankers should stick to the game on the pitch – surely exerting enough? Perhaps it’s time to get a Russian oligarch on board… after all, Mr A has done wonders for Chelsea!

    Angus Neill