August jobs report emerges as key test for whether U.S. bond yields will remain lower-for-longer

Treasury yields remain near their historic lows, despite two months of robust employment gains in June and July, suggesting investors believe that the pace of economic recovery from the pandemic has already peaked. The August data will offer a first look into how well the economy held up even as the coronavirus delta variant threatened to slow business and activity in some states.

The data release takes on greater significance considering Federal Reserve Chairman Jerome Powell on Friday reinforced the central bank’s intention to start winding down its bond-buying program this year. A number that matches or exceeds July’s payrolls gain of 943,000 would make it more likely that the Fed announces a tapering at its September policy meeting, while a miss would raise the odds of a delay, analysts say.

The next jobs report is “extremely significant” considering Powell’s emphasis on incoming data in his Jackson Hole speech on Friday, said Gennadiy Goldberg, a senior U.S. rates strategist at TD Securities in New York.

TD still has a forecast for the 10-year to finish the year at 1.75%, from its current level of around 1.31%, but also expects the August jobs data to show a sharp slowdown in payrolls growth. For the firm’s forecast to materialize by year-end, COVID risks would have to recede and any additional fiscal spending would need to add upward pressure on yields, he said.

If not as many jobs are created in August as forecast, that would “suggest that rates are lower for longer, the cost of capital for the market as a whole is also lower, and the amount of easing is quite a bit higher,” Goldberg said via phone. “It would become more difficult for the Fed to extract itself from easy policy,” while the central bank’s constant presence as a non-price-sensitive buyer in the bond market would continue to weigh on yields.

Bond investors reacted swiftly to Powell’s Jackson Hole remarks on Friday, with a rally in Treasuries that sent yields lower across much of the curve, on the view by some that a September tapering announcement isn’t likely to be on the way. Among other things, the Fed chairman failed to specify a timeframe for tapering and reinforced the notion that a pullback on bond purchases isn’t a signal about when a rise in policy rates might occur. He also emphasized that elevated inflation should be temporary.

“Powell’s overall tone could best be summed up as `flexibly dovish’, ” said Jake Remley, a senior portfolio manager at Boston-based Income Research + Management, a $90.3 billion institutional asset manager.” His speech gives the bulls “safe cover” to keep duration on for at least another week, according to Remley. It also likely exacerbates implied volatility going into the release of the August jobs number.

Policy makers “covet flexibility to interpret the incoming data as they see fit,” Remley said via e-mail to MarketWatch. “They don’t want the market to assume that they have a formula for setting policy and, if they do, they want to guard it as zealously as Coca-Cola does its eponymous soda recipe.”

The dovish tilt to Powell’s remarks sent stock indexes SPX DJIA further into record territory on Friday. Not even an inflation reading that came in Friday morning at a 30-year high was enough to derail investor sentiment that the Fed won’t be ready to scale back on its easy policy for at least a few more months.

“Powell gave something to everyone, and the Fed is going to err on the side of being as easy as possible,” said Brent Schutte, chief investment strategist at Northwestern Mutual Wealth Management Company   in Milwaukee. 

“Employment is where the rubber meets the road, and we’ll be looking to the August jobs report to see what the impact of delta has been on the economy. Is the economy as resilient to delta as we think it is? And are companies continuing to hire? ” he said.

 For now, “the Fed is going to keep being a buyer in the market, and continue to keep yields under control for at least a few more months,” said Schutte, who oversees $220 billion in assets from retail clients. “As long as global investors are looking for safer assets, people will still be attracted to U.S. yields.”