Jobs report complicates the picture for the Fed

This week has started where last week left off for financial markets and policy makers — that is, trying to assess how much of the surprisingly good US jobs report is real and how much of it could end up being a head fake. Although markets are not waiting for the answer, and understandably so given the deep win-win conditioning they have embraced, policy makers are in a tougher situation. This is particularly the case for Federal Reserve officials, who prepared for their two-day policy meeting from Tuesday. In addition to parsing the latest employment data, they have to
deal with the added complexity of the significant bear steepening
in the Treasury market yield curve recently.
As detailed here, the impressively strong jobs report may be a function of some combination of the following: A notably resilient US economy that is already picking up steam, the impact of policy measures such as the Paycheck Protection Program, and data issues that may be subject to revision. It’s unlikely that we will be able to sort out with confidence the relative contributions of these three factors before the next monthly jobs report at the earliest.
Markets are not waiting for such resolution, and for good reason. The dominating narrative in the marketplace remains that risk assets will gain from either a strong or weak economy because central banks will have no choice but to provide additional exceptional support in the event of a disappointment.
With that, asset prices have continued to move higher after the jobs report, especially those for heavily lagging “reopening stocks.” In doing so, they continue to outpace the improvement in the real economy in a striking fashion.
The resolution question is trickier for policy makers. With some politicians already suggesting that the report reduces the need for more stimulus, this puts even greater pressure on the Fed when officials are also trying to decipher the recent move up in yields coupled with significantly steeper for two- and 10-year and two- and 30-year Treasury curves.
Specifically, Fed officials need to determine the relative contributions of higher growth expectations, larger Treasury bond issuance because of the expanding fiscal deficit and lower investor demand because of skepticism about Treasuries’
traditional effectiveness to hedge portfolios.
For the reasons detailed herem even before the jobs report that, when it comes to new exceptional policy announcements this week, the Fed should stay on the sideline for now and instead focus on making the Main Street Lending program operational as soon as possible.
After all, markets are functioning well, liquidity is high, risk asset prices have been surging, and there is no evidence that tight financial conditions are holding back economic activity.
The central bank’s exceptional activism has been driven by two self-reinforcing narratives: “go big” and provide “insurance,” both of which have been reinforced by concerns about destabilising markets lest that add to the economic challenges.

—Bloomberg