A commentary by John Kerschner, Head of U.S. Securitized Products & Portfolio Manager at Janus Henderson Investors, related to this morning’s BLS Jobs report.
NFP came in significantly above expectations, rising 272,000 from April’s 175,000, with unemployment ticking up to 4.0%. There is a massive dichotomy between the Bureau of Labor Statistics NFP number (which comes from surveys of companies) at 272k and the Census Bureau’s job number which showed a LOSS of 408k jobs. The Census Bureau number drives the unemployment rate. Over the last year, these two measures of employment have diverged by almost 2.5mm jobs. The household survey paints a MUCH weaker job market. We would expect revisions in the NFP numbers in the months ahead to bring these numbers more in line.
Meanwhile, the path of central bank easing has started, although it hasn’t been uniform. The Bank of Canada was the first of the G7 to cut rates on Wed and the European Central Bank (ECB) quickly followed suit on Thurs, cutting rates in one of the most widely expected moves. This divergence in central bank policy is not unexpected, as guidance began to diverge earlier this year with less-sticky inflation in the Eurozone economy compared to the U.S.
How to interpret the latest jobs report?
Our take is this suggests the economy is slowly slowing and perhaps higher rates are starting to infiltrate through the economy and impact the market. With much of the recent data coming in softer than forecasted, expectations for Fed cuts have increased this week.
Expectations for rate hikes remain tempered from the 7 priced in at the beginning of the year to maybe one or two this year. We believe the Fed does want to cut this year, but a cut is unlikely to happen until September at the earliest. And when they do, it’s likely they message this does not kick off a consistent hiking cycle of 25bps per meeting, but perhaps a more infrequent cadence such as every other meeting. It doesn’t particularly matter if they start hiking in September or in November, what matters is the cadence from there.
An eventual easing cycle will not normalize the yield curve overnight. A deeply inverted yield curve may take quarters, if not years, to right itself. We think this happens with Fed cuts bringing the front end down, while the long end elevated, with room to rise modestly if U.S. inflation remains sticky. It’s important to remember that while investors got comfortable with zero-interest rate policy (ZIRP) over recent years, the 5-year and 10-year at just over 4% aren’t that far off fair value and we expect they can remain at similar levels while the front end of the curve adjusts.
What is an investor to do?
With an inverted yield curve and the expectation that rates remain higher for longer, investors are being compensated handsomely on the front end of the yield curve. This presents a unique opportunity to capture attractive yields with little duration risk and position a portfolio to capture capital appreciation potential when the Fed starts cutting. What stands to benefit the most? (1) Front end bonds that provide high carry and stand to benefit the most from rate cuts; (2) high quality AAA CLOs that offer historically attractive yields with little to no credit or duration risk; (3) agency mortgages, which tend to perform in a curve steepening environment (i.e. a inverted curve normalizing environment) and have essentially no prepayment risk today.
We would suggest investors remain aligned to their long-term goals by allocating across a well-diversified portfolio and look to capture unique opportunities for heightened carry on the front end of the curve.
