Paging Dr. Goldilocks

For those of you who slept in today, financial markets are enthused by this morning’s May Payrolls Report. Nonfarm Payrolls increased by 559,000, which missed a consensus estimate of 675,000 and “whisper numbers” as high as 1 million. The unemployment rate dipped to 5.8% from 6.1% and vs. 5.9% expectations and average hourly earnings rose by 2% ahead of a 1.6% expectation. The numbers showed that the labor market is continuing to recover, but not at a rate fast enough to spook the Federal Reserve. This is what we call a Goldilocks number – not too hot, not too cold. Just right.

For better or worse, markets and the Federal Reserve are joined at the hip. It’s been quite clear for at least a decade that monetary accommodation is perhaps the key driver of markets overall, and the stock market specifically. Equity futures rallied almost immediately after the release, which led me to make a snarky but accurate tweet about traders’ addiction to Fed liquidity. When it comes to economic outlooks, however, I tend to trust bond traders more than my equity brethren. Stock traders get consumed in stories (and memes) and second-order effects like earnings, while bond traders – particularly those who specialize in government bonds and money market instruments – have a largely undiluted focus on the economy and inflationary expectations. They share the enthusiasm.

Rather than unspooling a long narrative about today’s goings on, I’ll let some charts do most of the talking. Let’s start with a look at how the yield curve changed overnight:

US Treasury Actives Yield Curve, Today (green, upper) vs. Yesterday (orange, upper) with One-Day Change in Basis Points (lower)

US Treasury Actives Yield Curve, Today (green,upper) vs. Yesterday (orange,upper) with One-Day Change in Basis Points (lower)

Source: Bloomberg

The lower part of the graph tells the real story. We see yields falling from the 2-year portion through the 30 years. Stock traders used the 5 basis point drop in 10-year yields as a rationale to move into large-cap technology shares, pushing the NASDAQ 100 Index (NDX) up over 1.5%. Yet the 1 basis point drop in 2-year notes may be as significant if not more. It implies that even bond traders were focused more on the “Goldilocks” nature of today’s number holding back the timing of a potential rate increase rather than the inflationary implications of higher than expected wages.

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