Rate Hikes Are Back On The Agenda

Following this morning's release of the February jobs report, rate hikes are back on the market's agenda.

Over the past several months, there has been a growing sentiment in the investment community and in policy circles that despite unprecedented weakness in certain areas of the labor market - long-term unemployment, for example - overall labor market slack is disappearing as the unemployment rate falls, and the Federal Reserve is probably getting closer to considering hiking short-term interest rates than Fed officials want observers to believe.

"You can argue that maybe the Fed has convinced investors of their commitment to low policy rates and a slow pace of policy rate increase in 2015 and beyond, but we find a lot of skepticism among investors that there is as much slack out there as the Fed has indicated," said Steven Englander, global head of G10 FX strategy at Citi, before this morning's release.

"In fact, we think that a solid [nonfarm payrolls number] either in Friday's release or next month's will cause investor fears of Fed tightening to [rise] back up sharply."

Sure enough, the market's knee-jerk reaction has been to move up the timeline for rate hikes this morning in the wake of the release.

Money-market yields implied by 3-month eurodollar futures are up sharply, as are long-term interest rates - like the yield on the 10-year U.S. Treasury note, which is currently trading at 2.81%, seven basis points above Thursday's closing levels.

The Fed tightening trade has been derailed since shortly after the turn of the year by the recent slowdown in economic activity, much of which has been attributed to one of the worst winters on record in terms of bad weather. Investors betting on higher interest rates were forced to close out of costly short positions and wait out the weather until signs of clarity in the economic data emerged.

Although the February jobs report is noisy and subject to large revisions, a few items in the release may provide hints that the labor market is poised to re-accelerate as the blizzards recede.

Namely, the headline number of workers hired to nonfarm payrolls in February, at 175,000, was well above the Street's consensus forecast of 149,000, despite poor results from private-sector surveys released earlier in the week that suggested the risks were to the downside headed into today's release.

Meanwhile, the unemployment rate ticked up to 6.7% from 6.6% - but 610,000 were unable to work due to weather, almost double the historical February average of 317,000. That figure implies a lower unemployment rate, discounted for weather effects.

Perhaps most significant were the data on wages contained in the jobs report. Average hourly earnings of private-sector nonsupervisory employees rose 2.5% from a year earlier in February - a fresh cycle high.

Average weekly hours worked, however, ticked down to 34.2 from 34.3 in January - likely due to the impact of the harsh weather.

Nonetheless, the market's reaction so far this morning has been higher yields across the curve, and today's report is likely to add more fuel to the fire with regard to the debate over how tight the labor market actually is - and by extension, how close the Fed actually is to raising short-term interest rates.