CIO continues to favor high- quality fixed income, including government and investment grade bonds, which stand to gain in the event of a swifter-than-expected economic slowdown. (ddp)

The yield on the 2-year US Treasury rose to 5.11%, topping the level seen prior to the collapse of Silicon Valley Bank in early March to reach the highest level since 2008, before retreating later in the day. The real yield on the 2-year Treasury reached as high as 3% intraday, a post-financial-crisis high. Real yields on the 10-year Treasury rose to 1.78%, the highest level since 2008.

The move followed ADP data showing a 497,000 gain in private sector employment in June, more than twice the consensus forecast. Added fuel for the move came from comments by Dallas Fed President Lorie Logan, a voting member of the rate-setting committee this year, who said that “the FOMC needs to make policy more restrictive, so we can return inflation to target in a sustainable and timely way.”

But while investors will now be looking to the official June jobs data later today for confirmation, recent data has underlined our view that the Fed faces a tricky balancing act in achieving a soft landing.

Labor market strength still looks inconsistent with the Fed’s inflation target. It remains to be seen if the official June employment data confirms the strength suggested by the ADP survey. Economists have recently tended to underestimate the strength of jobs growth, with non-farm payrolls coming in above consensus forecasts for the past 14 months in a row. Again, investors will be hoping for signs of a gradual cooling of the labor market following a gain of 339,000 in employment in May, well above expectations. Meanwhile, unemployment looks set to remain low by historical standards. Economists expect the jobless rate to have fallen to 3.6% in June, from 3.7% in May, still close to April's 3.4%, the lowest level since 1969.

Core measures of inflation have been coming down, but slower than expected. The Fed’s favorite measure of inflation, the personal consumption expenditure index—excluding food and energy—moderated to 4.6% in May, down from 4.7% in April and from a peak of 5.4% in February 2022. However, it has shown no consistent downward trend this year, fluctuating between 4.6% and 4.7% throughout 2023. In his testimony to Congress late last month, Fed Chair Jerome Powell said, “inflation pressures continue to run high, and the process of getting inflation back down to 2% has a long way to go.”

The services sector still looks strong, while the manufacturing sector has been contracting for the past eight months. The task of achieving a soft landing is complicated by the divergence between the two main parts of the economy. The service sector, which has recently been the main source of inflationary pressures, remains robust, based on survey data. The ISM services index for June rebounded to a 4-month high of 53.9, compared to a consensus forecast of 51.2. Both the new orders and employment components of the services survey gained ground.

So, with risks to the economy still high, we favor fixed income over equities. We continue to favor high- quality fixed income, including government and investment grade bonds, which stand to gain in the event of a swifter-than-expected economic slowdown. All-in yields have become even more attractive. The 5% yield on 2-year US Treasuries, if sustained, would be consistent with investors doubling their money in roughly 14 years.

Main contributors - Solita Marcelli, Mark Haefele, Christopher Swann, Vincent Heaney, Jon Gordon

Content is a product of the Chief Investment Office (CIO).

Original report - Yields rise as investors look to jobs data, 7 July 2023.