The U.S. non-farm payroll data for September surpassed market expectations, indicating robust hiring momentum. This prompted traders to lower their bets on the extent of future rate cuts by the Federal Reserve. Before the data release, the bond market had anticipated a rate cut trajectory more aggressive than the Fed's stance for the remainder of the year.
This scenario has occurred before. Earlier this year, unexpected inflation and economic data eroded previous gains in U.S. bonds. Kevin Flanagan, Head of Fixed Income Strategy at WisdomTree, noted that the bond market is aligning with the Fed's projections as traders adjust their bets in response to resilient economic signals.
Market expectations for a 50 basis points rate cut in November have been dismissed. Currently, contracts indicate a 23 basis points cut. Swap contracts linked to Fed meetings suggest a total rate cut of approximately 53 basis points for November and December, down by more than 10 basis points following the data release. This aligns closely with the Fed officials' levels from the previous month.
Flanagan remarked that similar to last year's rally, U.S. bond yields need softening data for confirmation, with the 10-year yield likely to exceed 4% and approach 4.15%. The short end can remain below 4% as the Fed continues to ease policy as anticipated.
Post-data, the policy-sensitive 2-year U.S. Treasury yield initially climbed 17 basis points to 3.87%, marking the largest increase since April 10. Meanwhile, the 10-year yield rose 12 basis points to 3.96%. European bonds followed U.S. Treasuries sharply lower, with the German 2-year yield surging 13 basis points to 2.21%, erasing the week’s gains.
Traders also reduced rate cut bets for the European Central Bank and the Bank of England, although the overall outlook remains unchanged with expectations of five to six 25 basis points cuts next year.
Priya Misra, a portfolio manager at Morgan Asset Management, questioned whether the Fed will continue with rate cuts after this data, emphasizing that a 5% federal funds rate remains restrictive amidst a slowing economy. Misra anticipates a 25 basis points cut by the Fed next month, but advises monitoring inflation pressures closely.
Economists from Bank of America and JPMorgan reduced their November rate cut expectations from 50 to 25 basis points following the employment data release. Strategists highlighted the strong labor data, with September job growth exceeding forecasts, previous months revised upward, low unemployment rates, and higher-than-expected wage growth.
Gregory Faranello, Head of U.S. Rates Trading and Strategy at AmeriVet Securities, commented that this robust report led to higher U.S. yields amid improving data. He expects the Fed to persist with rate cuts, although the rate debate will intensify following the current data.
