Treasurys rallied, with short-term yields posting their biggest drop in a year, after softer U.S. jobs data prompted traders to boost bets that the Federal Reserve will lower interest rates as soon as next month.
Yields on two-year notes tumbled as much as 25 basis points to 3.71%, setting up the biggest drop since weak employment data released Aug. 2, 2024 teed up a series of Fed rate cuts. Traders fully priced in two rate cuts this year, with an 80% chance of a reduction at the next meeting in September.
The move weighed on the dollar, sending a gauge of its strength down as much as 1%, and deepened declines for U.S. stocks, which were already under pressure from new US tariffs announced late Thursday. The S&P 500 fell nearly 2% at one point.
The yield moves reflected a dramatic shift in sentiment around the monetary policy outlook, shaped in part by President Donald Trump’s relentless pressure on Fed Chair Jerome Powell to cut rates despite elevated inflation expectations related to the tariffs.
“We would look for the Fed to begin lowering rates in September,” said Gregory Faranello, head of US rates trading and strategy for AmeriVet Securities. “It’s somewhat amazing how you can have a sitting Fed Chair intimate the strength in labor one day and receive these numbers a few days later.”
Expectations for rate cuts collapsed on Wednesday after Powell’s latest comments on the outlook, less than an hour after Trump said it was his understanding the Fed would cut in September.
Friday’s rebound — a seeming validation of Trump’s view and those of two Fed governors he appointed, who dissented from the July 30 decision not to cut rates — may mark a turning point.
The moves were sparked by a report on U.S. labor that showed payrolls increased 73,000 in July vs a median economist estimate of 104,000.
Also, figures for the prior two months were revised down by nearly 260,000, bringing the average for the past three months to 35,000 — the lowest since the 2020 pandemic. The jobless rate ticked up to 4.2% from 4.1% as expected.
While the pace of hiring has been slowing since April, Powell on Wednesday said low unemployment indicated the jobs market was “in balance” as the administration’s crackdown on immigration has reduced labor supply.
On Friday, Fed Governors Christopher Waller and Michelle Bowman expressed concerns that policymakers’ hesitance to lower rates could risk damaging the labor market.
The two policymakers voted against the Fed’s decision this week to keep the benchmark borrowing costs in a range between 4.25% and 4.5%, favoring a quarter-point reduction.
Treasurys held onto their gains after a report showed U.S. factory activity contracted in July at the fastest pace in nine months.
Friday’s rally reversed Treasurys’ 0.4% loss last month, only the second monthly decline this year. The market is still up 3.4% for the year.
“It’s a big beautiful bond market,” Michael Collins, portfolio manager at PGIM Fixed Income, said on Bloomberg Television, echoing the moniker Trump gave to July 4 federal budget legislation that extended tax cuts and raised the debt ceiling. “We have been advising clients to take advantage of the rates while they are high.”
Collins said he prefers two- to 10-year Treasurys, where “you don’t have to take a lot of interest-rate risk to get a lot of benefit.”
The magnitude of the shift Friday was reflected in high trading volumes in Treasury futures. Some of that activity involved scrapping wagers on a flatter yield curve, a bet that yield gaps between short- and long-term Treasury yields would narrow.
That bet became a losing position in the rally unleashed by the jobs data. The two- to 10-year yield gap widened more than 10 basis points, the biggest move since April.
Friday’s job report led strategists at CreditSights Inc. to predict that the Fed will cut rates by 50 basis points in September, followed by two quarter-point reductions by December. Previously, they expected cuts to start in 2026.
“The risk that the Fed is behind the curve in the labor market has grown, especially when coupled with recent tariff announcements, which increase the effective tariff rate from May-July levels,” strategists including Winnie Cisar and Zachary Griffiths, wrote. They also see “a quicker path” for the 10-year yields to drop to 3.5% than previously expected.
A jumbo cut next month would be similar to what the Fed did in September last year when it started the easing cycle by lowering the rates by half a percentage point following a string of weak labor market reports.
In the short-term interest-rate options market, Friday’s flows included large wagers on a half-point rate cut in September and on quarter-point cuts at each of this year’s three remaining Fed policy meetings.
“The big picture is that you can cut the rate, you can get 100 basis points off this interest rate, and still be above where inflation is tracking,” said Rick Rieder, chief investment officer of global fixed income at BlackRock, adding that the Fed should start with a 50-basis-point reduction next month.
“Could you do 50, similar to what happened last year? Yeah, I think so,” he said on Bloomberg TV. “I don’t think it’ll have any debilitating impact on inflation.”
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