Yields surge

The 10-year treasury yield began the week at 4.73% before easing slightly to 4.68% on Thursday, reflecting persistent concerns over inflation, fiscal deficits, and the Federal Reserve’s cautious tone on rate cuts in 2025. Following a stronger-than-expected December jobs report showing 256,000 new jobs versus a forecasted 160,000, the 10-year yield traded as high as 4.79% before retreating slightly. These sharp moves highlight heightened sensitivity in bond markets as robust economic data clashes with expectations for monetary easing. The rising yields signal a reassessment of risk and duration in a higher-for-longer-rate environment.

• As we have been highlighting, since the Fed began cutting interest rates in September, yields on the long-end of the bond market have been rising
• While the Fed controls the overnight rate, the market dictates the long end of the bond market
• Most consumer and corporate credit is priced off the 10-yr treasury yield; hence a higher yield leads to higher interest rates for the consumer
• Consequently, the interest rate for 30-year fixed mortgages reached 6.93% this week, a level not seen since June 2024 and slightly off the high of 7.22% recently
• Long-term interest rates are also a negative for stock valuations, as stocks are generally valued by discounting their cash flows at the market rate of interest
• The higher the interest rate, the lower the present value of cash flows is
• There is also the effect of rising interest rate costs for companies that issue significant debt
• As companies are forced to re-finance existing debt at higher interest rates, their interest expense rises, negatively affecting their earnings to shareholders

Hint of inflation

The Institute for Supply Management (ISM) released its December 2024 reports, indicating varied performance across sectors. The Manufacturing PMI rose to 49.3% from 48.4% in November, signaling a slower contraction in manufacturing activity. In contrast, the Services PMI increased to 54.1% from 52.1%, reflecting stronger service sector expansion. Notably, the Prices Paid Index for services surged to 64.4, the highest since February 2023, indicating heightened input cost pressures and potential inflationary concerns.

• Inflation has been stubbornly sticky in recent months, even showing a slight re-acceleration
• Services, which includes shelter, medical care, transportation, education, and communication, have been more firm than other areas
• Prices paid for services in the PMI reported this week showed this trend may continue
• This data point added to worries that the Fed would not be able to cut interest rates again in the near term
• The market will be eagerly awaiting the next CPI (inflation) release next week to confirm

Strong job market

The U.S. labor market demonstrated robust growth in December 2024, adding 256,000 jobs and surpassing economists' expectations of 155,000. This expansion was driven by significant gains in healthcare, government, and retail sectors, reflecting strong consumer demand during the holiday season. The unemployment rate edged down to 4.1% from 4.2%, indicating a tightening labor market. However, average hourly earnings increased by only 0.3% to $35.69, suggesting that wage growth remains moderate despite the robust employment figures.

• We seem to be back in an environment where good news is bad news for the market
• Although the job market being strong is good for the economy, the stock market reacted poorly
• The S&P 500 was down over 1% on the news, while Treasury yields, as mentioned above, rose
• The chances of an additional rate cut at the end of January declined to just 5%, down from 28% last month
• Additionally, while wage growth was in line with expectations, a further tightening job market could lead to higher wage growth, which is inflationary

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