Why did U.S. Treasury yields rise sharply despite the significant drop in non-farm payrolls?

On Friday, the U.S. released the non-farm payroll data for October, with an increase of 12,000 jobs that surprised the market. However, after a brief drop, the U.S. dollar and Treasury yields quickly rebounded, with the 10-year Treasury yield soaring to 4.38%, up 10 basis points on the day.

Since the Federal Reserve cut interest rates on September 18, the 10-year Treasury yield has risen a total of 70 basis points, which has not been seen in previous rate-cutting cycles.

What exactly happened? I believe there are two reasons that can explain this:

First, the non-farm data isn't actually that bad.

The market had already anticipated poor non-farm data due to two hurricanes and a strike at Boeing, with many analysts even predicting negative values before the data was released. About 100,000 of the decrease was due to one-time factors (51,200 people were unable to work due to severe weather, and 41,400 were affected by the strike).

The expected unemployment rate of 4.1% and the better-than-expected hourly wage increase of 0.4%, along with Wednesday's ADP employment increase of 233,000, all indicate that U.S. employment is not weak, raising expectations for a soft landing in the U.S. The Federal Reserve is highly likely to cut rates by 25 basis points in November.

Here are two additional points of knowledge:

1. The sampling methods of ADP and non-farm payrolls are different. ADP samples weekly, meaning that anyone who gets paid during the month is counted in the employment population; whereas non-farm payrolls are based only on the payrolls from the week of the 12th of each month, counting only those who received wages that week as employed. Therefore, ADP is less affected by single-week hurricanes, while the observation week for October non-farm payrolls was indeed impacted by hurricanes.

2. In the household survey's unemployment rate, those who are absent and have no income are not counted as unemployed, while this group is included in the institutional survey's new employment figures, which can explain why the unemployment rate did not rise significantly. Additionally, since those who are working have to take on more work from absent colleagues, this may also be a reason for the increase in hourly wages.

Second, no one is buying U.S. Treasuries before the election.

During the upcoming election week, a total of $125 billion in U.S. Treasuries will be issued ($58 billion in 3-year notes on November 5, $42 billion in 10-year notes on November 6, and $25 billion in 30-year bonds on November 7). Looking back at the 2016 election period, demand for Treasury issuance was very weak (10-year and 30-year bonds tailing by 1.6 basis points and 1.3 basis points, respectively), and few are willing to buy Treasuries before the uncertainty of the election.

Moreover, there may also be liquidity issues in the Treasury market. The usage of the Federal Reserve's reverse repos has fallen to $155 billion for the first time since 2021, dropping by $46 billion overnight.

The surge in SOFR at the end of the month also indicates that dollar liquidity is tightening. At the end of September, the quarter-end SOFR briefly soared to 5.05%, exceeding the ceiling of IORB (4.9%) by 15 basis points, and at the end of October, which was just a non-quarter-end month, SOFR also surged to 4.9%.

Another indicator is the significant drop in the swap spread (the difference between the SOFR IRS of the same maturity and U.S. Treasury yields), where U.S. Treasury yields have risen more than interest rate swaps, indicating that as the U.S. fiscal deficit continues to expand, banks' balance sheet capacity is struggling to absorb all the U.S. Treasury supply.

The most important factor is still the election results. As the results of early voting are gradually announced, the probability of Harris winning is beginning to catch up with Trump, and the dollar showed a noticeable retreat at the market open on Monday morning.

Considering the scenarios for the election results:

(1) If Trump wins + the Republican Party controls both houses, the U.S. fiscal deficit will further expand, and the 10Y U.S. Treasury yield is expected to challenge 4.5%, with the curve steepening further;

(2) If Trump wins + a divided Congress, many policies will face significant challenges in implementation, and U.S. Treasury yields are expected to rise and then retreat;

(3) If Harris wins + a divided Congress, the market's prior panic pricing regarding the election will quickly recede. Considering that the current election premium for Trump is about 20 basis points, the 10Y U.S. Treasury yield is expected to return below 4.1%.

Author of this article: Fang Yuqi, Source: Good Morning Forex, Original title: "Why Did U.S. Treasury Yields Surge Despite a Significant Drop in Non-Farm Payrolls?"