Why Are Bonds Tanking Despite Weaker Jobs Report?

Nonfarm payrolls came in at 199k versus a median forecast of 400k.  On almost any NFP Friday before the pandemic, this would be worth some positivity in the bond market.  While that may have been the initial reaction in the first minute following the data, bonds quickly reversed course and moved into weaker territory.  What’s up with that?!  If this is confusing, I’d definitely recommend watching yesterday’s recap video starting at the 7:20 mark.

Notably and unfortunately, one of the points made in the video (which wondered how much weakness the bond market had left to give this week) is quickly proving to be premature.  As it happens, there was more than enough potential for pain based on intraday losses that have already hit 3/8ths of a point in MBS.  Looking at weekly candlesticks in MBS and Treasuries reinforces the severity of the current sell-off.

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Notice in the previous chart that 10yr yields are in the process of challenging the 1.77% technical ceiling.  They’ve made it as high a 1.783 as of this writing, but that has not yet resulted in any massive follow-through.  Attempted breakouts such as this can occasionally prompt value buying as opposed to more selling, but we probably won’t get a clean read on that until next week.

Even then, the market is clearly gearing up for what is now a very well telegraphed shift in Fed policy.  Let’s back up for a moment.  The market is actually gearing up for the second or third iteration of a well-telegraphed shift in Fed policy.  The first telegraph was sent in September when the Fed announcement prepped the market for an impending tapering announcement.  The next announcement in early November delivered that news, but it had already been priced-in due to September’s crystal clear telegraph.

The second iteration happened in mid December when the Fed accelerated the pace of tapering and released a dot plot showing a big acceleration in the rate hike outlook.  Markets did surprisingly well with that news due to the proliferation of omicron concerns.  As the narrative surrounding omicron began to shift (from exclusively bad to “maybe there are some silver linings here..”) and as new year trading positions rolled in, bonds began selling off at the beginning of this week. 

Then on Wednesday, the Fed unleashed its third iteration of telegraphy by saying it would likely be reducing its balance sheet a lot faster than it did the last time it attempted to “normalize” its accommodative policies.  This is the key factor driving trade in the past 2.5 days, and the market saw nothing in the morning’s jobs report to derail the Fed’s intentions.  This is the kind of mirror image trading in stocks and bonds that we usually only see when the market is repricing its idea of Fed accommodation potential.

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(NOTE: the chart above was snapped earlier in the day.  10yr yields are up to 1.792 as this sentence is being written).

The bottom line is that a very big, very important, and relatively abrupt “repricing” of expectations is taking place.  It has to do both with omicron’s impact and the Fed’s policy outlook.  Batten down the hatches, etc.  Things could get worse before they get better.

Here are a few bonus charts pertaining to today’s jobs report, submitted without comment:

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