U.S. yields little changed as jobs report raises inflation concerns

Treasury yields pared sharp gains on Friday after a strong U.S. jobs report for November showed a resilient labor market with rising wages, a potential thorn for the Federal Reserve as it moves to slow its hiking of interest rates to tame high inflation.

Nonfarm payrolls increased by 263,000 jobs last month as employees hired more workers than expected and data for the prior month was revised higher, the Labor Department said.

Another sign of a strong labor market was a 0.6% increase in average hourly earnings after a 0.5% advance in October. It was the biggest monthly rise in 10 months and nudged the annual rate to 5.1% from 4.9% in October. Wages peaked at 5.6% in March.

An initial jump in yields softened later in the session on investors adding longer-dated securities to their holdings on falling bond prices and the short-covering of positions, said Priya Misra, head of global rates at TD Securities in New York.

"The demand came in the 10-year, which to me is 'I am worried about a recession. It's going to happen next year, I should get out of my short' or 'I'm uninvested and we got a rise in rates, so I might as well take advantage of it'," she said.

The acceleration in average hourly earnings and a third-straight drop in labor force participation will likely trouble Fed policymakers, said Joe LaVorgna, chief U.S. economist at SMBC Nikko Securities in New York.

"Their intention from what Powell has said and from what the latest data show is that they will keep rates up at these levels until it's clear inflation is trending lower," he said, referring to the U.S. central bank chairman, Jerome Powell.

The report is "precisely what Chair Powell told us earlier this week he was most worried about. Wages are rising more than productivity, as labor supply continues to shrink," he said.

Brendan Murphy, head of global fixed income for North America at Insight Investment, said "the fact that earnings have spiked up again should give you a little bit of concern that inflation could be stickier than people expect.

"It's highly worrisome that it bumped up a bit," he said.

Futures showed the market expects the terminal rate to rise to 4.913% in May, up about 7 basis points from the day before. (FEDWATCH) The chance of a fifth-straight 75 bps hike when Fed policy-makers meet Dec. 13-14 rose to 23%, according to CME's FedWatch Tool. A 50 bps hike is still the greatest likelihood.

The terminal rate has changed the past few days on hopes the Fed can deliver a soft landing, said John Luke Tyner, fixed income analyst at Aptus Capital Advisors.

"It's time again to upgrade expectations of the terminal rate back higher, again. This report keeps pressure on the Fed to keep hiking and stay tight for longer," Tyner said in a note.

The two-year (US2YT=RR) Treasury yield, which typically moves in step with interest rate expectations, rose 0.5 basis points at 4.259%, while the yield on 10-year yield US10Y fell 3.5 basis points to 3.492%.

Earlier the 10-year yield briefly traded below 3.5% before the data's release, then shot to 3.638% before slipping.

The yield curve measuring the gap between yields on two- and 10-year notes (US2US10=RR), seen as a recession harbinger, was at -76.9 basis points.

The yield on the 30-year Treasury bond (US30YT=RR) was down 8.3 basis points to 3.550%.

The breakeven rate on five-year U.S. Treasury Inflation-Protected Securities (TIPS) (US5YTIP=RR) was last at 2.571%.

The 10-year TIPS breakeven rate (US10YTIP=RR) was last at 2.455%, indicating the market sees inflation averaging about 2.4% a year for the next decade.

The U.S. dollar 5 years forward inflation-linked swap (USIL5YF5Y=R), seen by some as a better gauge of inflation expectations due to possible distortions caused by the Fed's quantitative easing, was last at 2.558%.

Dec. 2 Friday 2:54 p.m. New York / 2054 GMT