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Traders Rip Up Bets on Big Fed Cuts as Jobs Data Hits Bonds

  • “Overall, it’s a very strong report,” said Gregory Faranello, head of US rates trading and strategy for AmeriVet
    Securities. “The US rate market has been leaning and consolidating higher in yield off the back of better data this week and the jobs report adds icing on the cake.”  Faranello expects the Fed will continue “to lower rates, but the debate around that pathway will be heightened after today’s release.”

Traders slashed their bets on the pace of future Federal Reserve interest-rate cuts after September US employment data blew past estimates and signaled a robust hiring trend.

The strong jobs report had traders shredding their aggressive bets for outsized rate cuts at the next policy meeting. Leading up to the data, the bond market had once more been running ahead of the Fed’s view on the trajectory of rate easing for this year. It is a pattern that has been seen before. During the opening months of this year the rally in Treasuries was unwound as inflation and economic growth data surprised to the upside.  “The bond market is gravitating back to the Fed’s dot plot,” said Kevin Flanagan, head of fixed income strategy at WisdomTree, adding that traders find themselves once again having to recalibrate their bets amid data that points to a resilient economy.

The chance of a half-point rate cut in November was priced out, with the contract showing 24 basis points of easing now
expected. Swap contracts tied to the outcome of future Fed meetings were pricing in only 53 basis points of rate cuts for
November and December combined, a drop of more than 10 basis points after the jobs report. Traders are aligning their rate-
cut bets with what Fed officials indicated last month via their
updated forecasts.

“Just like the rally at the end of last year, Treasury yields needed to be validated by weaker data and it would not be
a surprise to see the 10-year rise above 4% and head towards 4.15%,” said Flanagan. “The front end can hold below 4%, as the
Fed can keep easing in line with their forecast.” Treasury yields were close to session highs late in New
York, with the policy-sensitive two-year Treasury yield rising nearly 23 basis points to 3.93%, the biggest jump since April
10. Meanwhile, the 10-year note climbed nearly 14 basis points to 3.98%.

Treasury yields have climbed sharply from their closing levels at the end of August, and are now well above their lows
of September. In turn the popular yield curve steepener trade — that gained considerable momentum from traders pricing in more aggressive Fed easing — has come under mounting pressure this week.

The two-year yield sits around 5 basis points over the 10-year, and this curve measure has retreated from a recent peak of 23.5 basis points.

“There is definitely more room to go in the Treasury market selling off because everyone via positioning data was in
steepeners or holding two-year and five-years outright,” said George Catrambone, head of fixed income at DWS Americas. “There
will be more of an unwind in the front end and curve flattening positions until the next data point.”

European bonds followed Treasuries sharply lower. German two-year notes erased this week’s gains, with the yield spiking
as much as 13 basis points to 2.21%. Traders pared bets on rate cuts from the European Central Bank and the Bank of England. The broader outlook remained unchanged though, with the market pricing between five and six quarter-point reductions through next year.
After easing policy by 50 basis points last month to a 4.5%-5% range, Fed officials indicated only another half- percentage point of easing by December, and said that with inflation having moved back toward their 2% long-term target, they could be more attentive to the risks posed to the labor market.

“The question is whether the Fed will still cut rates on this,” said Priya Misra, portfolio manager at JPMorgan Asset
Management. “The funds rate at 5% is still restrictive and the economy is slowing.” Misra expects the Fed will ease by 25 basis points next month, although the market still needs to watch price pressures. Next week’s main data release is the consumer price index for September, and inflation still remains above the Fed’s long term target of 2%.

“Now that the labor market looks good, you do have to pivot back to inflation, especially as the service sector is fine,”
said Catrambone. “There is room for rates to go higher on a hotter CPI print and for rates to stabilize if the number shows
inflation is moderating.” Economists at Bank of America Corp. and JPMorgan Chase & Co. lowered their call for a half-point cut to quarter-point in November after the jobs data.

“Not only are we seeing a spike in yields across the curve, the increased prospect of ‘no landing’ has also eliminated a floor for Treasury prices predicated on Fed rate cuts designed to remove policy restrictiveness by reducing real interest
rates.”
— Edward Harrison, macro strategist. See more on MLIV.

The September jobs report showed an acceleration in wage growth to a 4% annual pace — the most since May — and it comes when oil prices have surged this week amid escalating tension in the Middle East, while industrial metals are also rallying in the wake of China announcing new stimulus efforts. Mohamed El-Erian, the president of Queens’ College, Cambridge, and Bloomberg Opinion columnist, told Boomberg Television Friday that the Fed would need to renew its focus on its fight against rising prices after September’s surprisingly hot jobs report served as a reminder that “inflation is not dead.”

The sentiment was echoed by JPMorgan Asset Management’s Misra. “If inflation risks increase, it calls into question the
entire easing cycle,” she said. Meanwhile, Federal Reserve Bank of Chicago President Austan Goolsbee warned Friday about inflation risk after noting that the central bank doesn’t want “to react too much to one month’s”
of jobs data.

Figures released Friday showed US employers created 254,000 jobs in September instead of the expected call of 150,000. The
unemployment rate dipped to 4.1%, while the past two months saw a net revision of 72,000 jobs.  “Overall, it’s a very strong report,” said Gregory Faranello, head of US rates trading and strategy for AmeriVet Securities. “The US rate market has been leaning and
consolidating higher in yield off the back of better data this week and the jobs report adds icing on the cake.”  Faranello expects the Fed will continue “to lower rates, but the debate around that pathway will be heightened after
today’s release.”