Friday's surprisingly robust U.S. jobs report is creating another point of contention in the already-wide disconnect between financial markets and Federal Reserve policy makers.
That's because the employment data for April could be taken in one of two ways.
On one hand, there was a better-than-expected 253,000 new jobs created, a sharp rise in hourly wages, and a drop in unemployment to 3.4% - all of which were seen as supporting the case for the Fed to remain vigilant on inflation, said investors, analysts, and some economists.
On the other, updated figures for March and February showed hiring wasn't as strong as initially thought, suggesting the labor market is already weakening, which was good enough for stock investors and for traders clinging to prospects for a Fed interest rate cut soon.
Taken together, the data drove another wedge into the big gap that exists between what financial markets and Fed officials are seeing and expecting. Fed policy remains strongly data dependent, as Chairman Jerome Powell made clear on Wednesday, when officials left themselves just enough wiggle room to hike rates again if needed.
Meanwhile, stocks rallied on Friday and fed-funds futures traders held on to a decent 38% chance of a quarter-point Fed rate cut in July, ignoring Powell's guidance to the contrary this week. Those traders mostly expect to see a total of three quarter-of-a-percentage-point rate cuts by year-end.
"We are in a situation where we will either see increased market volatility going forward or we will see a loss of Fed credibility. One of these two events will unfold in the coming weeks and months," said Gregory Daco, chief economist at EY-Parthenon, the global strategy consulting arm of Ernst & Young based in New York.
"The setup is one where we have banking-sector stress continuing to unfold, and the Fed being excessively data-driven," Daco said via phone on Friday. "If we get more reports like today, policy makers will maintain a hawkish tilt toward lifting rates. Some policy makers may argue that additional tightening is necessary, bringing the fed funds rate closer to 6%, but I don't think that's going to happen."
It was only a day ago that regional-banking woes had investors and traders searching for safety, in contrast to Friday's risk-on momentum in equity markets. On Thursday, an aggressive rally in government debt pushed the 2-year Treasury yield to an almost eight-month low, dragging the 10- and 30-year yields down with it. Traders priced in a risk of a Fed rate cut as soon as June. And all three major U.S. stock indexes finished lower, led by a 0.9% drop in Dow industrials, on Thursday as shares of PacWest Bancorp lost more than 50% of their value after being halted throughout the day.
Read: 'Taking out the hike that just happened': Traders ignore Powell and begin pricing in a Fed rate cut as soon as June
By Friday, stocks and bonds were doing the opposite of what they did a day ago. All three major U.S. stock indexes DJIA SPX COMP ended the day higher, led by an almost 2.3% rise in the Nasdaq Composite, as stock investors focused on revisions showing a total of 149,000 fewer job gains for March and February than initially reported. Regional banks' shares also staged a recovery, with PacWest's shares ending up by more than 80%.
Meanwhile, investors sold off most government debt, pushing rates on 6-month Treasury bills through 30-year Treasury higher. The 1-month T-bill rate jumped a whopping 90.8 basis points to 5.462% as of 3 p.m. Eastern time versus where it closed on Thursday, according to Tradeweb.
Just as traders priced in a greater-than-not likelihood of no action by the Fed in June or July, Ronald Temple, chief market strategist at Lazard, wrote in an email that "if the Fed was expecting definitive confirmation it's time to pause, this [Friday's jobs report] is not that signal . All said, 500bps of rate hikes are having an impact, but it's too early to declare victory over inflation."
Financial markets and the Fed remain "on two different pages," said Keith Buchanan, a senior portfolio manager at GLOBALT Investments in Atlanta, which oversees around $2.5 billion. "The Federal Reserve is talking about putting the lid on inflation for good, which will require more debate on what policy is appropriate going forward. The market is calling for a retreat by the Fed pretty quickly.
"That gap has to close. It's unsustainable and there is a ticking noise in the background that is the clock between now and the next two meetings," Buchanan said via phone. "The market has to come to where the Fed is, which will produce volatility, or the Fed has to come where the markets are, which would produce a loss of Fed credibility."
For now, GLOBALT favors large-cap growth stocks, which "should retain their value better than the rest of market," and has held a position in gold for some time on the view that it should achieve more value, he said on Friday.
At Glenmede Investment Management in Philadelphia, Rob Daly, who oversees $4.5 billion as director of fixed income, said that "the likelihood of the Fed continuing to tighten conditions is there and I come away asking, 'Where are we going to go with rates?' The market is still pricing in rate cuts this year, which doesn't make sense to me, and uncertainty equals volatility.
"Fed officials have their eye on financial stability, but it doesn't seem to me that's their main focus. I think they are going to continue on the track of tamping down inflation," Daly said. Meanwhile, "the Fed is leaning toward a place where it could lose its credibility. Markets are invested in what they want to hear, which may not come to fruition, and we could see a Fed that stops and restarts again down the road. That's a big risk that is not being priced in."