by Brad Houle, CFA
Principal
Fixed Income Research and Portfolio Management
Jobs Data
Today the employment data for the month of June was released and was stronger than analysts’ expectations. Nonfarm payrolls increased 372,000 in the month of June, well above the estimate of 265,000. In addition, average hourly earnings growth moderated on a month-to-month basis, which should help the inflationary pressures in the economy.
Bonds Acting Like Bonds
2022 has been the worst year for bonds in the modern history of the bond market. For the first half of 2022, bond indexes are down more than 10%. This decline in the value of bonds is due to the persistent elevated level of inflation and the Federal Reserve’s aggressive response. The fixed returns from bonds are negatively impacted by an elevated rate of inflation. In a normal environment, bonds earn their keep in client portfolios by being inversely correlated with stocks. Said differently, when stocks decline in a "risk-off" environment bonds generally increase in value as interest rates fall. Bond math is counterintuitive: when interest raises rise, bond yields decline. This year's downturn in the stock market has been accompanied by a concurrent decline in bond prices as well which is exceedingly rare. In fact, this has only occurred on a full-year basis twice in the last one hundred years.
However, more recently bonds have begun to act more like bonds. The 10-year U.S. Treasury yield has declined from 3.5% in the middle of June to 3.09% where it is today. This decline in interest rates has been accompanied by a continued "risk-off" environment for stocks. Bond performance in the last couple of weeks has been consistent to the historical relationship.
The underlying cause for the change in tone of the bond market is softer economic data consistent with a maturing economic cycle. In addition, the market’s expectations for future inflation continues to decline. Our view is that inflation is in the process of peaking, however, it will take a few months for the trend to fully manifest. The inflation report for the month of June will be out on July 13 and the expectation is for an 8.8% gain on a year-over-year basis in the Consumer Price Index (CPI). Core inflation, which excludes the volatile food and energy segments, has already started to decline. Oil prices have declined in the month of July and this development should be apparent in the July inflation report due out in August.
Data as of January 2019 - June 2022
Source: Bureau of Labor Statistics
Our view is that the economy is not going into a recession in the near-term. If we do have a recession, it will be a shallow one. Consumer spending is robust, employment is healthy with 3.6% unemployment rate and corporate balance sheets are in great shape.
We are not calling for a top in bond yields or that elevated persistent inflation is over, however, the trends seem to be moving the right way. This change in trend has been evidenced by the price action in the bond market that has started to cushion the decline in the equity markets.
Takeaways for the Week
The June employment report released this morning showed the labor market remains strong with 372,000 jobs added over the month
Bonds have been providing portfolio insurance in a risk-off environment over the recent past