(Bloomberg) — Treasury yields surged as surprise strength in the US labor market forced traders to once again question whether the Federal Reserve can cut interest rates this year.
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Two-year rates, more sensitive than longer maturities to changes in the Fed’s policy outlook, rose nearly 15 basis points to 4.87% after the US government’s May employment report showed job and wage growth exceeded expectations. Yields of all maturities rose at least 12 basis points, while swaps traders pared back their rate-cut bets for 2024.
Still-robust US labor conditions also pushed economists at Citigroup Inc. to change their forecast for the first US rate reduction to September from July. Ahead of next week’s key inflation report and Fed policy decision, JPMorgan Chase & Co. remains one of the few major Wall Street banks that sees a July cut.
“This data keeps the resilient employment narrative alive another month and leaves the onus on CPI to drive the dot-plot,” said Ian Lyngen, head of US rates strategy at BMO Capital Markets, referring to next week’s consumer price index and an update of Fed officials’ quarterly rate projections, known as the dot plot.
In a year that’s seen the Treasury market whipsawed repeatedly by surprising economic data, the jobs report offered the latest reason for traders to brace for volatility. The jump in US yields comes just after global government bonds recorded their longest rising streak since November, supported after the Bank of Canada and European Central Bank lowered borrowing costs this week
Ahead of Friday’s employment data, positioning data in the Treasury market showed traders biased toward dovish bets, which stood to profit if rates fell. Options linked to the secured overnight financing rate — which closely follows Fed policy expectations — had also shown traders wagering on as many as two rate reductions this year.
Those traders have since pulled back on rate-cut expectations, pricing in the first full 25 basis points of easing in December — rather than November. Block activity in the Treasury options market on Friday has also indicated investors are pulling back on bullish wagers established a week ago.
“Sentiment was on the bullish side in the bond market heading into the jobs number,” said Kevin Flanagan, head of fixed income strategy at WisdomTree. “What this number does is keep in place a 10-year yield of 4.5%, plus or minus 10 to 20 basis points either side.”
The data sets the stage as US policymakers meet for a two-day policy meeting next week and release an update to their rates forecasts. In March, officials signaled three quarter-point cuts to come this year. Strategists widely expect them to downgrade this to two — or even only one — cut in 2024.
BMO’s Lyngen said he expects short-term Treasury yields to keep moving higher in the wake of the US jobs report. Nonfarm payrolls advanced 272,000 last month, a Bureau of Labor Statistics report showed, beating all projections in a Bloomberg survey of economists. The unemployment rate increased to 4% from 3.9%.
Also troubling bond traders was that average hourly earnings climbed 0.4% from April and 4.1% from a year ago.
“Despite some market chatter about imminently slowing growth, there’s not much hard data to support the idea,” said Guy LeBas, chief fixed income strategist for Janney Montgomery Scott. “Labor market demand is high, corporate profits are growing, and consumer incomes continue to move higher. There is absolutely nothing in today’s report which gives the Fed a reason to cut, and plenty of things which give them a reason to hold off.”
–With assistance from Edward Bolingbroke and Michael Mackenzie.
(Updates rates throughout and adds details on trader positioning.)
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