Strong Labor Market Data Sparks Bond Selloff

The moves extended a volatile week in which the two-year yield, which is highly sensitive to Fed policy expectations, traded Friday nearly a quarter percentage-point lower than highs seen earlier in the week. 

Treasury yields overall initially climbed on Monday in response to a burst of corporate bond issuance and better-than-expected manufacturing data. They then dropped sharply over the next three days amid resurgent concerns about the health of regional banks—only to be buoyed again Friday by the strong jobs numbers and a rebound in bank shares.

Some analysts said the conflicting signals about the economy are leaving many investors guessing about the path of rates. Concerns that a significant lending pullback could be looming has also put the Fed’s senior loan officer survey, due Monday, in the spotlight. The consumer-price index for April is due on Wednesday, followed by supplier inflation on Thursday.

Friday’s jobs data “probably has the Fed confused, much like the rest of us,” said Brian Jacobsen, chief economist at Annex Wealth Management. “We will see what next week’s inflation report says, but maybe the Fed should just be relieved that inflation is gradually falling and the labor market isn’t falling apart.”

After the Fed raised rates by 0.25 percentage point Wednesday, Chair Jerome Powell reaffirmed the central bank’s commitment to using economic data to guide its policy decisions. 

But analysts said the outlook remains hazy. On one hand, the regional banking trouble threatens to slow lending and the economy. On the other hand, Friday’s data showed the labor market has resisted the central bank’s efforts to cool it. 

On Thursday, yields fell after shares of PacWest and Western Alliance plummeted; both bank stocks were halted for volatility. Futures-market bets implied the Fed might even cut rates by a full percentage point this year. Then, on Friday, both banks recovered some of their losses, and the strong jobs data left traders easing off those bets.

“Things are so fragile in the market right now that you see massive reactions to every word or data point,” said Lee Ferridge, head of macro strategy for North America at . “There is so much uncertainty; everyone is looking for direction.”

Traders have been persistent in their bets that the Fed will cut rates later this year. Federal-funds futures contracts show the policy rate finishing the year just above 4.4%, according to .

To be sure, many Wall Street analysts see rates staying high in the back half of the year. Some said futures contracts may be more indicative of hedging against a so-called “black swan” event, where the banking mess spins into a full blown financial crisis or the economy plunges into a deep recession. And many expect better outcomes. 

“The case of avoiding a recession is, in my view, more likely than that of having a recession,” said Mr. Powell at his press conference on Wednesday.

Policy makers have pushed back on the idea that they’ll lower rates, highlighting that inflation remains strong and rates must remain in “restrictive territory” to slow the economy. Mr. Powell left the door open for further tightening in his Wednesday remarks, though he largely signaled a pause. 

Some investors say that when zooming out from the daily—often whipsawing—market reactions, stocks’ resilience this year has been encouraging.

“I’m actually impressed with the market, because it hasn’t sold off despite everything that’s happened thus far,” said Phil Pecsok, chief investment officer of Anacapa Advisors. “I’m not really sure the Fed is going to cut; but if they do, there’s likely more money that will come into the stock market.”

Write to Eric Wallerstein at [email protected]

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