Market Extra: Bond traders don’t care about nonfarm payrolls anymore, in one chart

For bond traders, nonfarm payrolls was once the king of economic data.

Now, that monthly data point is no longer a market-mover, said analysts at J.P. Morgan led by Jay Barry. They found its place at the top gave way this year to an inflation reading, which has overtaken the jobs report’s role as a driver of Federal Reserve policy actions.

“Yields have become more sensitive to core CPI (consumer-price index) surprises as focus has turned to the inflation side of the Fed’s dual mandate,” the fixed-income strategists said. Core CPI measures consumer prices excluding the volatile food and energy categories.

Their findings reflect that even as the gap between a solid economy and muted inflation have widened, investors have grown increasingly sensitive to signs of price increases. After the unemployment rate hit multidecade lows, the Fed and investors have concentrated on a lack of accompanying wage increases, the force expected to spur inflation and the central bank to normalize rates.

As a result, the three most important readings to bond traders now are core CPI and two underlying contributors, retail sales and average hourly earnings, the analysts said.

They found that over the last three years, the 10-year Treasury note yield TMUBMUSD10Y, +0.53% would move at least 1.5 basis points in the two hours after any one of those three pieces of economic data performed better or worse than expected, that is, delivered a surprise (see table below). One basis point is one hundredth of a percentage point.

The influence of nonfarm payrolls on bond markets has evaporated

In contrast, jobless claims, nonfarm payrolls data and the unemployment rate had weak explanatory power for Treasurys trading after a data release. The regression coefficient, or “fit”, for the nonfarm payrolls number plummeted to 6% this year from 46% in the prior two years, whereas the fit for the core CPI reading jumped to 58% in 2017 from 11% in the past two years.

A higher regression coefficient implies that there is a much stronger relationship, or fit, between yield movements and a piece of economic data.

In effect, the analysis reveals a sea change in the drivers of the bond market, which unlike stocks are more sensitive to the swings and sways of the overall economy. A few years ago, job market data ruled the roost when slack was noticeably absent in an economy still recovering from the depths of the 2007-2009 recession.

But after the unemployment rate fell to unforeseen lows this year and inflation shrugged off the tightening labor market, the traditional relationship between low unemployment and rising inflation was thrown out of the window.

“If unemployment goes further down without inflation going up, its kind of business as usual,” said Marvin Loh, senior fixed-income strategist at BNY Mellon.

Personal-consumption expenditures stripping out for energy and food prices, the Fed’s preferred inflation gauge, saw a 1.3% annual rise in the three months between July and September, below the central bank’s 2% target, even as the unemployment rate hit 4.1% in October.

The string of tepid inflation reports have concerned Fed officials who see it as harbinger of a more lasting trend. Outgoing Federal Reserve Chairwoman Janet Yellen last week expressed concerns about stubbornly below-target inflation. If it remains subdued, the impetus to raise and continue normalizing interest rates may not be apparent, she said.

Read: Yellen says inflation below 2% goal poses one of Fed’s ‘biggest challenges’

Yet it might be dangerous to assign too much importance to inflation in the coming months. The central bank has raised rates twice in 2017 even against lackluster data on the basis that raising rates too gradually could overheat the labor market and put the Fed behind the curve.

“Everything the Fed says, we’re going to overlook the short-term data bounces, so the market is now looking past the data,” said Loh.

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