Great Jobs Throw Cold Water on Rate Cuts

Wages & Prices

I hope everyone had a Happy New Year and a great holiday season. The last few weeks have been a typical slow period for the markets and 2024 gets started in earnest on Monday. We did get some important jobs data on Friday that showed a healthy labor market with wage gains of 4.4% on an annualized basis. Good news for the economy but contrary to the hopes of the Fed which is concerned inflation will be re-stoked in 2024.

1-Mo CHange in Payrolls

However, the Fed may be seeing that job gains are coming from fewer industries (healthcare/government) which are insulated from the business cycle. As you can see on the adjacent graphic, this means the job market doesn’t look quite as healthy as it does on the surface. Still, jobs are jobs and they count as the labor market is tight as evidenced by the recent wage gains.

Quantitative Tightening Hums in the Background

The Fed continues to shrink its balance sheet despite taking a break on the rate hikes as you can see in the chart below that shows the size of their bond holdings (Treasury and mortgages). Still a long way to go before they get back to the pre-COVID level and there has been no talk about pausing this part of their hawkish policy. I expect that this activity will remain in the background despite the Fed’s contemporary policy on rates.

Fed Balance Sheet.

10Yr Treasury Yields

The chart below of the 10Yr Treasury yield shows a high in October near 5% after rising for over three years. It is now likely re-tracing this rise to the 3.25% area which should take several months. Afterwards, I expect 10Yr bond yields will continue higher and maker a new high above 5% sometime over the next 1-3 years. Of course, a chart doesn’t tell you why or predict what will act as a catalyst at every turn but this is a good roadmap for the longer-term path of long bonds.

Chart of the 10Yr Treasury Yield

The Yield Curve Will Eventually Steepen

If the above plays out like I expect, the Fed Funds Rate could remain unchanged (5.25%-5.5%) or maybe drop modestly while long bonds rise and that would be perfectly normal. In the long run, a healthy economy has a steep yield curve where 10Yr bond yields are higher than the Fed Funds Rate. As you can see below, the yield curve remains inverted and 2024 is probably the year where it begins to steepen. This could mean a variety of outcomes but today the market expects the Fed Funds Rate will drop 100bps (or more) in 2024 but the odds of that dropped on Friday with the healthy jobs report.

Yield Curve by @kiscocap

The Stock Market

The S&P 500 had a nice pivot higher from a low on October 27th. However, many stocks are overbought now and the major technology companies look overvalued here so there should be some corrective price action for the month of January. Too early to tell if the market will consolidate and trade sideways or re-trace a decent portion of the advance from the October low. Stay tuned…

Chart of the S&P 500 by @kiscocap
Paul McCarthy of Kisco Capital, LLC

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Paul J McCarthy III CFA

President, Kisco Capital

Paul McCarthy

Mr. McCarthy is the President and founder of Kisco Capital.