Treasury yields stay key market focus despite weak payrolls

Friday's softer US jobs report may have offered markets some welcome relief before the weekend, but it does not shift the key focus for traders this week. That focus remains the bond market.

The September employment report revealed non-farm payrolls increased by only 29k, far beneath forecasts. Initially, 10-year Treasury yields dropped following the release, reaching a low of 5.16%. That decline was short-lived. Yields recovered swiftly, ending the week around 5.28%, underscoring the fragility of any bond-market relief.

In that reaction, the rebound in yields could be seen as more significant than the initial drop to the labour market data.

Although the payroll figures have eased some pressure on the Fed's decision before its October meeting, traders have not completely abandoned the tightening narrative, and that warrants caution.

At present, markets are pricing in an approximately 82% probability that the Fed will keep rates unchanged at its October meeting. That represents a modest increase from the roughly 72% chance seen before last week's jobs data.

Still, a 25 basis point rate increase is strongly anticipated for December. Fed funds futures indicate an approximately 83% likelihood that the central bank will raise rates in the last month of the year. Thus, the signal is not that the Fed has finished policy tightening. Rather, it is that the Fed may have more leeway to delay and evaluate additional inflation and economic developments.

Here lies the larger issue for bonds. The factors driving long-term yields upward are not limited to the Fed's actions at its next meeting. Persistent fiscal deficits, substantial Treasury supply, and an increasing term premium are all crucial elements prompting investors to require greater compensation for owning longer-dated securities.

Therefore, the focus remains on the trajectory of Treasury yields, especially at the long end.

Should yields begin moving back toward last week's highs in the face of softer economic data, that would indicate that structural pressures continue to dominate the bond market. If that scenario unfolds, equities might find it difficult to sustain any lasting relief, even as expectations for a Fed rate hike in October recede.

On the economic calendar, the next important US data point is the September CPI report due on 14 October. That release will be key in deciding whether the Fed can remain patient.

Beyond that, the US midterm elections on 3 November will also spotlight fiscal policy and government finances.