Markets See Summer of Fed Easing at Full Speed Ahead

$100 bil U.S. dollar
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Stocks rose with the dollar and bond yields, as traders viewed the May jobs report as strong enough to signal continuing economic growth, but not so strong as to push the Fed toward a wind down of easing.

In another volatile session, markets Friday unwound some of the maneuvering that took place Thursday, when some traders in the bond market were expecting the jobs report to be far weaker. The markets have been fixated on when the Fed will begin to slow down its bond purchases, and there's been a lot of volatile trading as Fed officials discussed "tapering" purchases in the past several weeks.

"We'll have three more employment numbers before the Fed meets in September, so I don't think today's number is strong enough one way or the other to impact the tapering debate," said Marc Chandler, chief foreign exchange strategist at Brown Brothers Harriman. "Whatever your view was before, you're not going to change your mind. We are in the middle of something bigger…the bigger thing is yields have bottomed and I think we're adjusting to that."

(Read More: No Swoon: Job Creation Continues, Rate Up to 7.6%)

The Dow was up as much as 200 points, and the 10-year yield reached 2.15 percent from an intraday low of 2.03 percent. "FX is especially volatile and so is fixed income," Chandler said. "The dollar initially sold off and then it rose. Dollar/yen got down to 95 and now we're trading at 97. It was a two percent move in an hour's time."

The 175,000 nonfarm payrolls created in May were slightly higher than the 170,000 expected. However, there were downward revisions that subtracted 12,000 jobs from March and April. The unemployment rate rose 0.1 to 7.6 percent. The report showed a continued weakness in manufacturing, with a third month of losses.

Wall Street's view on when the Fed would start to reduce its $85 billion a month bond buying has been shifting as Fed officials have been discussing their views on paring back purchases. The most important comment of all perhaps came in late May when Fed Chairman Ben Bernanke told Congress the Fed could consider trimming purchases in a couple months if the employment picture and economy improve enough.

"That was sort of the pivot point May 21. That introduced a whole lot of bond volatility," said LPL Financial strategist John Canally. In the week ended Wednesday, more than $9 billion left bond funds, the second biggest exodus since Lipper began collecting fund flow data in 1992.

That comment from the Fed chairman also made Friday's May employment report an even more anticipated piece of data than usual, due to its importance as a metric for Fed action that now had a potential time frame. The views on when the Fed will start to wind down purchases remain disparate but there are many who believe it could be as soon as September. There are others who see the Fed continuing at full speed into 2014, and the views of when the Fed will stop purchases altogether span from the end of this year into 2015.

"I do think at the end of the day Fed tapering and the bond market have some correlation, but the real thing the bond market should be looking at is the overnight rate. if they're going to keep that low until 2015 that should anchor 10-year yields in the 2.40 range," Canally said.

(Read More: For Some Investors, Fed Can Start Tapering NOW)

Bond yields have moved into a higher range since the last jobs report, in part on a view the economy was improving but of late, on a view the Fed could taper its purchases of Treasurys and mortgage securities. Mortgage rates have also been rising, and last week, the 30-year mortgage was above 4 percent for the first time in a year.

"From the Fed's point of view, this is wholly desirable," said Chandler. "Nobody's going to accuse the Fed of creating bubbles. This setback in the market has blown off the froth. I think by moral suasion and forward guidance, they have effectively let some air out of what the critics argued was bubbles."

The 175,000 nonfarm payrolls is consistent with the trend of the past four years, and of sluggish GDP growth of about 2 percent, said Mark Zandi, chief economist at Moody's Analytics.

"Nothing has changed" in terms of the Fed, said Zandi. "It's going to be September, October. The September meeting has a press conference. That would be a natural place to do it."

Gary Thayer, Wells Fargo Advisors chief macro strategist, however, does not believe the Fed will slow down purchases that soon because of sluggish hiring, and he does think the May employment report now means the process could be pushed back.

"We think we're just in a period where there could be move volatility, and we do expect the economy to improve and stocks to go higher," Thayer said. "After today, the expectations about tapering are going to be pushed forward a bit. I think people were worried the economy was getting too close to the point where the Fed would taper. and clearly we're not rushing to that point."

Canally said the actions of the Fed has encouraged the volatility, since many Fed officials have different views on when the Fed should pull back from the program. The "tapering" is also not an end to the program, and Fed officials have made it clear they could increase purchases again if the economy needs help. Canally said, however, it's not clear whether the Fed would start to unwind its program if it sees steady job growth at current levels, or it needs to see a level of 200,000, as suggested by Chicago Fed President Charles Evans.

(Read More: Greenspan: Taper Now, Even If Economy Isn't Ready)

"I think the best outcome for the markets might be to get some specifics from the Fed in the FOMC minutes. I think the jobs report was good. It's not great. It's not a game changer," he said. "If you're in the 200,000 camp, then you need a whiz bang jobs report in June."

Now with the jobs report out of the way, the Fed-sensitive markets will be watching the next Fed meeting, with a statement and Bernanke press briefing June 19.

In the meanwhile, markets are expected to remain volatile. "The thing we've identified, as being the big switch here is this bond market volatility that's been introduced, and that's made the market more volatile. This has taken the stock market rally since the beginning of the year, and put it in perspective. I think that's going to be the hallmark of the second half of the year. It's the end of the 30-year bull market in bonds," said Canally.

(Read More: Markets May Have Gone Too Far on Taper Talk: Plosser)

MKM's Michael Darda points out that average monthly job growth of 189,000 in 2013 is running slightly ahead of 2012's 183,000. He notes "despite massive hand-wringing about the effects of the sequester, average job gains this year are actually slightly stronger than the average of 2012, meaning the Fed, unlike the ECB, has likely offset the impact of austerity" on nominal GDP.