Jump for Treasuries as traders await payroll data

A rally in Treasuries extended into a seventh straight day, as traders looked to upcoming jobs data to justify increasingly aggressive bets on a rapid succession of interest-rate cuts.

Markets now see the Federal Reserve delivering three consecutive quarter-point cuts in September, November and December — and are pricing a more than 30% chance that one of those reductions will be 50 basis points.

The policy-sensitive two-year yield slumped to its lowest in 14 months, while rates on the benchmark 10-year security held below 4% after falling to that level on Thursday for the first time since February.

The sharp recalibration in expectations for US rates came after the Fed held rates again this week. While Federal Reserve Chair Jerome Powell signaled that central bank officials are on course to cut interest rates at their next meeting, economic reports on Thursday showed rising jobless claims and weaker manufacturing, spooking investors that the Fed may already be behind the curve.

The shift in pricing “reflects investors’ growing concern that the FOMC might need to cut rates more quickly than the 25-basis-point quarterly cadence as economic headwinds continue to mount,” said Ian Lyngen, head of US rates strategy at BMO Capital Markets. 

Powell repeated on Wednesday that the Fed is data dependent when deciding when to lower interest rates, and emphasized that policymakers are mindful of the risk to the the labor market of waiting too long.

Ahead of the meeting, former New York Fed President William Dudley and Mohamed El-Erian warned that the Fed risks making a mistake by holding rates too high for too long. Both were writing as Bloomberg Opinion columnists.

That narrative has started to take hold in the past 24 hours. But bond market exuberance means that if Friday’s employment report shows signs of unexpected strength, there’s a risk some traders will dump bullish wagers en masse.

A $12 million wager has emerged in options linked to the Secured Overnight Financing Rate, which closely tracks Fed policy expectations, targeting some 225 basis points of easing by the middle of 2025. Even with the recent explosion of bets, the market is pricing in about 160 basis points by then.

WHAT BLOOMBERG STRATEGISTS SAY...

“Bond traders who have recently jumped into tactical long positions are riding a winning streak, but face a massive risk event with Friday’s payrolls report, which could produce a quick profit-squeeze on bullish wagers. This can hamper an extended move under 4% for the 10-year yield.”

— Edward Bolingbroke, rates strategist. Read more on MLIV.

Still, forecasters anticipate the report will show moderating job and wage growth in July, underscoring an ongoing softening in the labor market. And with markets now positioned so heavily for cuts, that could prompt investors to look through any unexpected strength.

“It seems like the employment data is trending toward less strength and more balance in Fed vernacular,” said Jack McIntyre, portfolio manager at Brandywine Global Investment Management. In that context, “the market would view tomorrow’s employment report as an aberration, if it came out strong,” and any weakness in Treasuries is a buying opportunity, said McIntyre.

It’s reminiscent of the energy early in 2024, when investors had priced in more than half a dozen reductions for the year before being forced to reassess their outlooks.

The Bloomberg US Treasury Index returned 2.2% in July, capping a three-month streak of gains and closing at its highest in two years. 

“Worries are definitely building that the Fed would have to take a faster calibration path to lower rates,” said Eugene Leow, a Singapore-based senior rates strategist at DBS Group Holdings. “The market is probably focusing on asymmetrical risks as labor market concerns come to the fore.”