US government bonds and stocks drop after hot jobs report

US government bonds and stocks sold off on Friday after employment data showed red hot labour conditions, leading traders to boost their expectations for Federal Reserve rate increases.

Treasury yields shot higher after the closely watched US jobs report showed employers added 528,000 jobs in July, more than double the 250,000 expected by economists and up sharply from 398,000 in June.

The two-year Treasury yield, which is sensitive to monetary policy expectations, surged more than 0.2 percentage points to 3.26 per cent — a sharp jump for a market that typically moves in small increments. Longer-dated bonds came under more subdued pressure.

Meanwhile, the S&P 500 fell 0.6 per cent by the afternoon as traders worried about the prospect of further hawkish rate rises from the Fed.

“The narrative is going to be that it’s come in way too hot, the Fed is right, and the markets were wrong,” said Jim Paulsen, chief investment strategist of The Leuthold Group. “I think it’s a muted response . . . on the stock and bond market relative to the emotion generated by the headline numbers.”

Trading in federal funds futures now shows that markets are expecting the Fed’s main interest rate to hit 3.64 per cent in February 2023, from an estimate of 3.42 per cent in the previous session. The federal funds rate currently stands at a range of 2.25 to 2.50 per cent.

The strong jobs data, which also showed the unemployment rate ticking down, pushed back against concerns that the world’s biggest economy may be headed for a recession. It could also give the Fed impetus to continue with its rapid increases, after it pushed borrowing costs higher by 0.75 percentage points in both June and July.

“The unexpected acceleration in non-farm payroll growth in July, together with the further decline in the unemployment rate and the renewed pick-up in wage pressure, make a mockery of claims that the economy is on the brink of recession,” said Michael Pearce, economist at Capital Economics, who added that “all the details [of the report] appear to support continued aggressive rate hikes from the Fed”.

The US dollar followed Treasury yields higher on Friday, with an index tracking the currency against half a dozen peers up almost 1 per cent. The pound and euro each dipped about 0.7 per cent, while the Japanese yen tumbled about 1.8 per cent.

In equities European stocks fell, with the regional Stoxx 600 closed down 0.8 per cent, after gains for Asian shares, with Hong Kong’s Hang Seng index up 0.1 per cent.