Bond Market Mayhem .... Rates Higher For Longer ...

Wall Street had expected 170,000 jobs to be created in September. The U.S. economy added 336,000 jobs, more than double the level economists had expected. The data underscored just how much strength remains in the labor market despite the Fed’s campaign to cool things down. Job growth for both July and August was also revised upward, showing a combined 119,000 more jobs had been created than previously reported. Unemployment remained steady at 3.8%. Earnings eased back in the latest data.

Forecasts for growth in the U.S. have now been upgraded to over 2%. The good news on inflation continues. The bad news, the markets assume the Fed will hike rates further in November. We had always assumed a 25 basis point hike was coming before the end of the year.

Mayhem in the bond markets? Not really. Ten year bond rates increased to 4.8% from 4.6%. Thirty year gilts closed just under 5% at 4.96%. Short rates three months, closed at 5.5%. Markets are conditioned to expect rates to be higher and for longer than expected earlier in the year. We have long warned of this, in the adjustment process to life after Planet ZIRP

In the U.K. ten year gilts closed unchanged at 4.6%. 30 year gilts closed up 13 basis points at 5.05%. Six month rates were at 5.5%. One year rates eased back to 4.9% from 5.15%.

No mayhem involved. The yield curve is normalizing. In the UK, prior to the Great Financial Crash [2000 - 2008] the average inflation rate was 2.0%, the average UK bank rate was 4.50%. Ten year Gilt yields averaged 4.50%. Thirty year gilts averaged 4.6%, real GDP growth averaged 2.5%, earnings averaged 3.5% and the unemployment rate averaged 5%. So what happens next in the U.K.?

We expect a further 25 basis point rise before the end of the year. Base rates rising to 5.5%. Rates then on hold, this could be it for the cycle. The Bank will be keeping a close watch on earnings. Wages increasing at over 6%, is just not compatible with a 2% CPI target.