(Bloomberg) -- Traders' hopes for a bond rally were dashed by surprise strength in the US labor market that raised odds the Federal Reserve will keep interest rates higher for longer.
Treasury yields surged across the curve on Friday, while traders — as well as economists at JPMorgan Chase & Co. and Citigroup Inc. — pushed out their expectations for the Fed's first rate reduction. This comes after the Bank of Canada and European Central Bank this week became the first Group-of-Seven economies to begin to normalize interest rates, stoking optimism the tide is turning globally.
On Wall Street, evidence of still-robust US job growth is wiping out optimism that had swept across bond markets since late May thanks to an array of data that hinted at a cooling economy. Two-year rates, more sensitive than longer maturities to changes in the Fed's policy outlook, rose nearly 15 basis points to 4.87% on Friday, before paring gains to hover around 4.85%.
"The gyrations in the bond market over the last weeks are of the extremes — pretty incredible," Rick Rieder, BlackRock's chief investment officer of global fixed income, said on Bloomberg Television. "I think the Fed would still like to get a cut or two done" this year, he said.
Policymakers are expected to leave rates unchanged at their meeting next week, which coincides with the release of consumer price index data for May on Wednesday.
In a year that's seen the Treasury market whipsawed repeatedly by surprising economic data, the jobs report offered yet another reason for traders to brace for volatility.
Global government bonds had recorded their longest rising streak since November before the jobs figures sent US yields surging. Yields across the US curve remain higher by at least 10 basis points on Friday.
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. After the data, Citi economists changed their forecast for the first US rate reduction to September from July, while JPMorgan pushed its call out to November.
"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."
To Ian Lyngen, head of US rates strategy at BMO Capital Markets, the latest data "keeps the resilient employment narrative alive another month" — and puts the onus on next week's consumer price index to drive the update of Fed officials' quarterly rate projections, known as the dot plot.
In March, officials signaled three quarter-point cuts to come this year. Strategists widely expect them to downgrade this to two — or even one — cut in 2024.
Lyngen said he expects short-term Treasury yields to keep moving higher in the wake of the 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, Michael Mackenzie and Ye Xie.
(Updates rates throughout and adds JPM's change to Fed call.)
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