By Sam Goldfarb

U.S. government bonds pulled back Friday as the latest jobs report showed solid wage growth, raising the prospect of higher inflation and tighter monetary policy.

The U.S. economy added 156,000 new jobs last month, compared with the forecast of 183,000 by economists polled by The Wall Street Journal. Average hourly earnings for private-sector workers rose 10 cents, or 0.39%, from the previous month, beating expectations and marking the largest annual gain in more than seven years.

Along with being good news for workers, wage growth can be a sign of broader inflation, which erodes the fixed returns of bonds and can leadto a faster pace of interest-rate increases from the Federal Reserve.

In recent trading, the yield on the benchmark 10-year Treasury note was 2.407%, according to Tradeweb, compared with 2.348% just before the jobs report was released and 2.370% Thursday.

The yield on the two-year Treasury note, which is highly sensitive to the Fed's policy outlook, was 1.206%, compared with 1.154% Thursday.

Yields rise when bond prices fall.

"The focal point of the report should be the story on wages," said Anthony Karydakis, chief economic strategist at Miller Tabak. Even without a change in fiscal policy, "the economy left to its own devices right now suggests that the Fed has good reason to take a close look at the situation in terms of the need for another move," he added.

Though substantial, the rise in long-term bond yields Friday wasn't enough to offset a large decline Thursday when investors dialed back on many trades thathave been popular since the election. Investors remain focused on the political prospects for more expansive fiscal policies out of Washington and already had a fairly positive view of the economy heading into the jobs report.

Fed-funds futures, which are used to place bets on central bank policy, showed that investors and traders see a 39% likelihood of a rate increase by the Fed's meeting in May, compared with 35% Thursday, according to CME Group. The odds of the Fed raising rates twice, or half a percentage point, by November climbed to 55% from 48%.

Higher interest rates tend to dilute the value of outstanding bonds, especially those with shorter maturities.

The yield on the 10-year note hit 2.6% in mid-December, up from 1.867% on Election Day. But yields have declined in recent weeks reflecting a sense among investors that the postelection bond selloff may have been overdone.

Many investors expect President-elect Donald Trump and a Republican-controlled Congress will increase the budget deficit by cutting taxes and boosting spending on defense and infrastructure.

Such policies could diminish the value of outstanding government debt by adding to the supply of bonds. They could also spur growth and inflation, which would chip away at the fixed returns of bonds and possibly lead the Fed to quicken its pace of interest-rate increases, delivering another blow to bond prices.

Still, the exact details of Mr. Trump's policies remain unclear. There are also questions about how much impact fiscal stimulus would have on an economy that faces long-term challenges, including weak productivity growth.

Even before the election, bond yields had begun to climb from record lows reached over the summer amid signs of faster economic growth and higher inflation. Nevertheless, inflation remains relatively muted and the Fed officials have offered little indication that they are poised to raise rates at the rapid pace that characterized previous periods of monetary policy tightening.

The Fed raised short-term interest rates in December for the second time in a decade and projected three rate increases this year.

Minutes of the December meeting released Wednesday showed officials had a mixed view of the economy even as about half of them incorporated fiscal stimulus into their forecasts. Among the risks cited was a strengthening dollar, which could make it harder for inflation to reach the Fed's 2% target.

Write to Sam Goldfarb at sam.goldfarb@wsj.com

(END) Dow Jones Newswires

January 06, 2017 11:08 ET (16:08 GMT)

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