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: Traders are questioning if Federal Reserve has missed the boat on inflation ahead of Friday’s U.S. jobs report

Traders are questioning whether Federal Reserve policy makers have already missed their best opportunity to get a handle on persistently higher U.S. inflation, as financial markets turn their attention to Friday’s monthly payrolls report.

With Fed officials remaining patient about raising interest rates and relying on incoming economic data, traders will be zeroing in on the labor-force participation rate which has remained mired within a narrow range below pre-pandemic levels for well over a year because many Americans have chosen to sit on the sidelines.

See: U.S. economy seen adding 450,000 jobs in October despite labor shortage

A failure to bust out of that tight range again in October’s data would mean that businesses will likely need to entice workers back with even higher wages, a key ingredient of inflation. For now, though, investors retain confidence in the Fed’s view that inflation is expected to be transitory, but some are also starting to question if central bankers have completely missed the boat.

“It’s a question we’re all asking,” said John Farawell, executive vice president and head trader with bond underwriter Roosevelt & Cross in New York. “We don’t really know what’s going to happen moving forward, and tomorrow’s number could be really significant because it would give us a signal about whether a lack of more people coming back into the labor force will mean wages go up and get passed on to consumers.”

Monthly U.S. nonfarm payroll reports tend to always be widely followed by markets, but the October report takes on added significance after the Federal Reserve decided on Wednesday to stick with its transitory view on inflation and to be patient about raising interest rates, while tapering bond purchases. For the most part, financial markets took the Fed’s update in stride, with the S&P 500
SPX,
+0.27%

and Nasdaq Composite indexes
COMP,
+0.83%

hitting fresh intraday records on Thursday.

Treasury yields were lower across the board too, suggesting that investors remain confident the Fed will ultimately keep inflation under control, while the economic growth outlook has diminished, Farawell said via phone. But that view of the Fed “can change quickly” after Friday’s data, he said.

Meanwhile, the differential between 5-year
TMUBMUSD05Y,
1.100%

and 30-year yields
TMUBMUSD30Y,
1.961%
,
as well as the gap between the 2-year
TMUBMUSD02Y,
0.414%

and 10-year
TMUBMUSD10Y,
1.520%
,
widened as of 10 a.m. Eastern time Thursday as traders priced in less monetary tightening in the U.S. and other countries than previously expected, according to data from Tradeweb. The widening differentials may mean that the worrisome signs of an economic slowdown seen over recent weeks have eased up a bit.

The U.S. labor-force participation rate began falling off around the onset of the COVID-19 pandemic in the U.S., and has remained within a narrow range of 61.4 percent to 61.7 percent since June of 2020. The median forecast of analysts is for a nonfarm payroll gain of 450,000 in October, up from 194,000 the prior month. The unemployment rate is seen as edging down to 4.7% from 4.8%.

Interest-rate increases from the Fed tend to hit the economy with a six- to nine-month lag, meaning that hikes delivered next year are likely to have no actual economic impact until 2023. Meanwhile, consumer price index readings have come in at 5% or higher on a year-over-year basis for five straight months, and some traders in recent weeks have been pricing in headline CPI gains of 6% or higher for the next three months.

“The market is increasingly skeptical – as are we – that policy makers will be able to maintain these low levels of rates for another year, let alone two, against the backdrop of extremely elevated inflation pressures and rising inflation expectations,” Lindsey Piegza, Stifel’s chief economist, wrote in a note.

“The Fed wants to quell inflation and keep inflation expectations in check,” she wrote, but at the same time the rate-setting Federal Open Market Committee “recognizes that the economy remains still somewhat fragile, or at least increasingly dependent on the monetary punch bowl.”

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