Why the Dow brushed off surging Treasury yields after a hot May jobs report

A hot jobs report Friday sent shivers through the bond market, prompted yet another repricing of rate-cut expectations and may have ruined Federal Reserve Chair Jerome Powell’s weekend.

Stock-market investors, in contrast, remained relatively calm, with the S&P 500 SPX and Nasdaq Composite COMP booking small losses after flirting with record finishes. What gives?

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“Looking at the equity side, it is a good environment from an economic perspective to see more jobs coming in and wages up,” and that’s good news for corporate earnings, Charlie Ripley, senior investment analyst at Allianz Investment Management, told MarketWatch in a phone interview.

To those uninitiated in the logic of Wall Street or central banks, a strong jobs report would intuitively be read as unalloyed good news. But for investors, hot data can mean trouble if the Federal Reserve is perceived as needing to tighten monetary policy — or in this case, keep rates elevated — in response to inflation.

Treasurys sold off, sending yields (which move opposite to price) jumping Friday. The yield on the 2-year Treasury note BX:TMUBMUSD02Y, the most sensitive to policy expectations, jumped 15 basis points to end at 4.87%, while the 10-year Treasury note BX:TMUBMUSD10Y rose 14.8 basis points to 4.428%.

After an initial wobble, stocks rose in Friday’s session but edged back into losing territory by the closing bell, with the Dow Jones Industrial Average DJIA posting a small loss of 87.18 points or 0.2%, while the S&P 500 shed 0.1% and the Nasdaq Composite fell 0.2%.

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Rising Treasury yields can unsettle stocks, particularly if the rise is rapid. Higher yields imply higher borrowing costs but, more important, can make equities less attractive relative to bonds as they pay more attractive yields than was previously the case.

What’s behind the seeming disconnect between Friday’s Treasury selloff and the steady-as-she-goes stock-market reaction? Treasury traders appear to be reacting, in particular, to the wage data contained in the jobs report, Ripley said.

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Average hourly earnings jumped again in May, pushing the increase over the past year up to 4.1% from 4%. The Fed wants to see annual pay gains slow to 3% or less to help the central bank return U.S. inflation to low prepandemic norms.

The wage data “really draws attention to the idea that inflation is still here and it’s going to still be here for a bit, despite the Fed’s effort to bring it down,” Ripley said. “That means rate cuts for the Fed are being pushed out even further.”

Fed policymakers meet next week. Investors aren’t looking for any policy moves when the meeting concludes on Wednesday, but will be paying close attention to the central bank’s policy statement, remarks by Powell and, perhaps most of all, an update to the central bank’s Summary of Economic Projections, also known as the “dot plot.”

The dot plot reflects individual policy expectations among Fed officials. Investors will want to see how many rate cuts they’re pricing in. The last dot plot, issued in March, showed policymakers, overall, looking for three quarter-point cuts in 2024.

Meanwhile, fed-funds futures showed any lingering hopes for a quarter-point rate cut at the Fed’s July meeting all but evaporate after the jobs data, while also reflecting lower probabilities for cuts later in the year. Fed-funds futures show a roughly 50% prospect of the equivalent of two quarter-point cuts by the Fed’s December meeting, according to the CME FedWatch Tool.

It’s also worth noting that despite Friday’s jump, yields still saw weekly declines and have pulled back significantly from late-April highs that saw the 10-year yield above 4.70% and the 2-year rate above 5%.

Stock-market investors, meanwhile, seem to be less concerned about the exact timing of a rate cut, remaining confident in the prospects for a modest economic slowdown, or “soft landing,” Ripley said.

And fears about a hard economic landing appeared to fade after a rebound in the Institute for Supply Management’s May service-sector PMI index on Wednesday broke a string of weaker-than-expected economic data.

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