• US jobs report gives Fed space to be aggressive in rate hikes
• Policymakers worry about inflation expectations becoming unanchored
• ECB debates anti-fragmentation tool as views diverge on risk premiums

A strong US on Friday is fueling investor optimism about avoiding a recession, but stocks declined amid fears of the Federal Reserve response.

The jobs report is a two-edged sword because strong hiring – non-farm payrolls rose by 372,000 compared to consensus forecasts of 268,000 – makes it easier for Fed policymakers to be aggressive in their rate hikes because they don’t have to worry about unemployment. An increase of three-quarters of a percentage point – 75 basis points – is .

Yield on the benchmark shot up above 3% after the jobs report, getting near 3.1% before settling at 3.080% in late trading.

The minutes from the June meeting of the , released last week, indicated policymakers are poised to raise the fed funds rate by 50 or 75 bps, but FOMC members have recently come out in support of the higher number.

The rate-setting panel members worried in June that inflation expectations could become unanchored: “Many participants judged that a significant risk now facing the committee was that elevated inflation could become entrenched if the public began to question the resolve of the committee to adjust the stance of policy as warranted.”

The for June due out this week is forecast to come in at about 8.8% on the year, while the is 1.1%. But forecasters erred badly in their May consensus as the CPI rose 8.6% instead of the expected 8.3%.

Will the June figure be a peak as Fed rate hikes, actual and expected, depress demand?

The European Central Bank also last week as investors braced for a shift to more aggressive monetary tightening. The question is whether the governing council will stick to its guidance of a quarter-point hike in July or go for something bigger.

“A number of members expressed an initial preference for keeping the door open for a larger hike at the July meeting. They remarked that the current signal should not be seen as an unconditional commitment,” the ECB minutes said.

Mohamed El-Erian, the former CEO of Pimco who is now an economic adviser for German insurer Allianz told business daily Handelsblatt that the ECB should by 50 bps in July. El-Erian has also been pushing for the Fed to be more aggressive in combating inflation.

Meanwhile, the ECB is wrestling with the issue of fragmentation – the widening of the spread in the yields of government bonds among eurozone members as high inflation and the prospect of higher rates has a bigger impact on highly indebted countries like Italy.

Greek central bank governor Yannis Stournaras said in a television interview over the weekend that the proposed anti-fragmentation tool might never be used if it is credible enough to keep yields in check.

This is what happened with the Outright Monetary Transaction tool announced in 2012 during the euro debt crisis, which was never used because it seemed to fulfill the pledge of then ECB President Mario Draghi to do whatever it takes to preserve the joint currency.

Not everyone agrees with Stournaras’s dovish view. The hawkish president of Germany’s Bundesbank, Joachim Nagel, said last week it would be dangerous to interfere with the risk premium investors put on the bonds from highly indebted countries. This ECB governing council member says the central bank would be sailing into “dangerous waters” if it second-guessed markets.

Disclosure: The author has no positions in any instruments mentioned.

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