(Bloomberg) -- Bond traders are looking to a key jobs report this week to confirm their wagers that the US economy is strong enough to push the Federal Reserve to lift interest rates by next year.
Beyond developments in the Middle East, a big focus will be Friday's release of monthly employment figures, which are projected to show the labor market remained resilient in May. Combined with elevated oil prices and reaccelerating inflation, that may bolster expectations that officials will remove the easing bias in their statement in June, in the Fed's first meeting under Chairman Kevin Warsh.
Traders see a hike by mid-2027, if not sooner, underscoring how the spike in energy prices as a result of the Iran war has upended expectations that Warsh would deliver cuts soon after taking over. By Bloomberg Economics' calculation, the jump in bond yields since the conflict began has already tightened financial conditions by the equivalent of about three-quarters of a percentage point of Fed rate increases.
"Yields have risen, and it's adding restrictiveness to the US economy and doing the work of the Fed," said George Catrambone, head of fixed income at DWS Americas. As rates climb in maturities from two to 10 years, he said, "you're really creating some headwinds that will eventually come through."
Add in the hit to wage growth from hot inflation, and mounting stress on the American consumer will weigh on the economy, Catrambone says. He favors owning two-year notes and has bought the 10-year near recent peaks.
While benchmark 10-year yields are down from their peak a couple weeks ago, they rose three basis points to 4.47% Monday as oil prices rebounded from a six-week low amid signs a resolution to the war remains elusive. Other bond markets globally also fell, with the equivalent German rate rising four basis points to 2.98%, while the UK 10-year yield rose three basis points to 4.84%.
However, US 10-year rates, a benchmark for mortgages and corporate borrowing, are still roughly a half-point above levels at the end of February. One options trade that emerged last week targeted the 10-year yield rising above 5% within months, a level not seen since 2023.
Market Crossroads
It all places added importance on the May employment report, which will follow a slew of other labor indicators this week, including job openings figures and ADP Research private-sector hiring data. The economy probably added roughly 90,000 jobs, keeping the unemployment rate steady at 4.3%, according to a Bloomberg survey.
"If the inflation numbers stay high and job growth remains solid, then the market could start to price in a more aggressive shift higher in rates from the Fed," said Gregory Faranello, head of US rates trading and strategy for AmeriVet Securities. "One hike will not do anything here."
Data last week showed the Fed's favored inflation measure — the personal consumption expenditures price index — rose 3.8% annually in April, well above the long-run rate of 2% that officials target.
With expectations for Fed tightening building, shorter-maturity yields trade above the central bank's current policy range of 3.5% to 3.75%. The roughly 4% yield on the two-year, which is especially sensitive to Fed expectations, is about 0.6 point higher than in late February. The jump has brought it closer to yields on longer-maturity debt.
"Global markets, not just US Treasury yields, are all reflecting this dilemma of how much higher can we afford to have inflation go, and when or if will it become a problem for growth," said Cindy Beaulieu, chief investment officer for North America at Conning, which manages about $190 billion.
A resilient labor market leaves bond traders and the Fed watching how inflation develops. A growing number of officials have said they want the central bank to signal its next move is just as likely to be a hike as a cut.
At Wellington Management Company LLP, Loren Moran had been "cautious" toward government bonds amid the prospect of quicker growth and inflation as a result of all the capital spending fueling the artificial-intelligence boom.
But as yields surged and expectations for Fed hikes climbed, the portfolio manager says short-term notes "are really attractive relative to what long end yields are, and offer a defensive place to hide out."
What Bloomberg strategists say...
Treasury yields have already repriced significantly higher, financial conditions have tightened, and the market's focus is shifting from whether the Fed needs to deliver rate hikes to whether the economy can absorb the heavy lifting that bonds have already done.
—Alyce Andres, macro strategist, Markets Live. For the full analysis, click here.
What to Watch
- Economic data:
- June 1: S&P Global US manufacturing PMI; ISM manufacturing; construction spending
- June 2: JOLTS job openings; Wards total vehicle sales
- June 3: MBA mortgage applications; ADP employment change; S&P Global US services and composite PMIs; ISM services index; Durable goods, factory and capital goods orders; Fed Beige Book
- June 4: Initial jobless claims; Challenger job cuts; nonfarm productivity; unit labor costs
- June 5: Nonfarm payrolls, unemployment rate, average hourly earnings and labor force participation rate; consumer credit
- Fed calendar:
- June 2: Minneapolis Fed President Neel Kashkari; Cleveland Fed President Beth Hammack
- June 3: Governor Michael Barr; Dallas Fed President Lorie Logan
- June 4: Richmond Fed President Thomas Barkin; San Francisco Fed President Mary Daly
- Auction calendar:
- June 1: 13-, 26-week bills
- June 2: 6-week bills
- June 3: 17-week bills
- June 4: 4-, 8-week bills
--With assistance from Edward Bolingbroke and Matthew Burgess.
(Updates yield moves in sixth paragraph.)
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