Weak Jobs Report Validates Bullish Bond View

The job report came in weak at 29k vs. expectations of 90k and with net two-month revisions at negative 60k. In addition, the unemployment rate ticked up to 4.2%.  Also, wage growth moderated to .1% vs. .2% expectations for the month with the year-over-year rate down to 3% from 3.1%

The weak report validates our view that the Fed’s hawkish policy stance is completely irrational, and it will only hike a maximum of one more time. Inflation data actually supports a cut with CPI core declining by .5% over the last 4 month to 2.4%, which is exactly at the Fed’s target as core CPI usually comes in at .4% over PCE core. PCE core is overstated by approximately 1% due to bad imputed price estimates for software, portfolio management and health care.  CPI core adjusted for market prices vs. the 2-year delayed shelter component of CPI is only 1.3%.  PCE core adjusted for market rents is only at 2.1%.

The Fed’s hawkish outlook has driven up Fed Funds futures up by over 150bp from the year’s low which in turn drove the 10-year treasury up 1.25% and the 30-year mortgage up from a low of 6% to 7.28%. In addition, interest sensitive stocks are down over 10%.  Consequently, the Fed’s assertion that financial conditions are loose is completely false. The housing and construction market are already in recession.

Due to the sharp rise in the 30-year mortgage we expect the housing market to enter a deep recession which will put pressure on the job market and cause economic growth to slow to the 2% area, which is over 1% below normal growth.  We also expect CPI core will continue to decline as money supply growth continues to be negative and the shelter component gradually reflects the decline in market rents.  The inflation and employment data will result in only one or zero rate hikes.  The 10-year treasury trades almost exactly 100bp over the terminal Fed Funds rate resulting in a likely 4.75-5.00% treasury yield. Treasuries in that range are consistent with a 20x multiple on the S&P and validates our 8,300 target on the S&P.

We are hopeful that the Warsh reform task forces will result in improved inflation index calculation, an inflation forecasting model that includes the critical money supply and emphasizes failed Keynesian metrics, and makes the arbitrary 2% target more flexible.