© 2024 Arizent. All rights reserved.

Bonds stumble as strong labor market is seen delaying rate cuts

Bloomberg

(Bloomberg) -- A rough start to the year for bond investors worsened Friday as strong employment data clashed with expectations that the Federal Reserve will cut interest rates this year.

Traders ceased fully pricing in a Fed rate cut before September after the March employment report revealed that US payrolls expanded by the most in nearly a year and the unemployment rate declined.

Treasury yields approached their highest levels this year, with the benchmark 10-year rate jumping as much as nine basis points to about 4.40%. The two-year note's yield reached its highest level of the day after Dallas Fed President Lorie Logan said it's too soon to consider cutting interest rates, echoing other central bank officials earlier this week.

Swap contracts that predict the central bank's rate decisions trimmed the probability of rate cut in June — which Wall Street banks including Goldman Sachs Group Inc. and Citigroup Inc. continue to expect — to about 52%. For July the probability dropped below 100%, and for all of 2024, traders priced in about 65 basis points of rate cuts, fewer than Fed officials' 75-basis-point median forecast last month.

"This data certainly doesn't give the Fed the impetus to cut anytime soon," said Peter Tchir, head of macro strategy at Academy Securities Inc. "Treasury yields are poised to continue to move higher. The strong data and rising oil prices likely means the 10-year yield is headed to crack 4.5% to 4.6%."

Shortly after 3 p.m. New York time Treasury yields of all maturities were at least six basis points higher on the day, with the two-year higher by 9 basis points. Five- to 30-year yields remained below year-to-date highs reached earlier in the week in response to strong economic data, rising oil prices and hawkish comments by two other Fed officials — Atlanta Fed President Raphael Bostic and Minneapolis Fed President Neel Kashkari. 

The selloff was limited by other elements of the employment report including a rise in labor-force participation with the potential to temper wage pressures, Randall Kroszner, a former Fed governor who's a professor at the University of Chicago Booth school, said on Bloomberg Television. The participation rate inched up to 62.7% from 62.5%, exceeding consensus estimates of 62.6%.

Still, the job-creation data — "alongside other recent US data showing incredibly strong economic momentum at the turn of the year" — was enough for Pacific Investment Management Co. to change its Fed policy forecast to just two quarter-point rate cuts this year, from two or three, Tiffany Wilding, an economist at the firm, said in a note.

At the start of the year, expectations were widespread that the Fed's 11 rate increases in the past two years would not only curb inflation but also cause economic stress, leading the central bank to drop rates by at least 1.5 percentage points this year. Instead, progress toward lower inflation has slowed, growth metrics have remained robust, and investors continue to shovel money into stocks and corporate bonds at a pace that suggests the economy doesn't yet require lower rates.

"The data are modestly bearish for bonds in that they cement the probabilities of a later start to rate cuts," said Guy LeBas, chief fixed income strategist for Janney Montgomery Scott. The data also reduce the risk of a recession, leading investors to demand higher rates of return.

Strategists at ING Financial Markets warned ahead of the jobs report release that the benchmark 10-year yield is set to revisit the 4.5% level last seen in November before a massive year-end rally kicked in. In the options market, traders also were set up a few days ago with wagers targeting a move to almost 4.5% and for overall higher yields.

Read more: Forces Build for US 10-Year to Revisit 4.5% as Jobs Data Await

What Bloomberg Intelligence Says..

"It'll be difficult for the Fed to make the case to cut rates if they are truly data dependent. We'll look at 4.5% as the next important technical level for 10-year Treasury yield."

— Ira Jersey

Treasury investors next week have the opportunity to buy three- and 10-year notes and 30-year bonds at auctions beginning Tuesday. Whether higher yield levels boost demand for the auctions will be key. The bond market continues to benefit from conviction that yields are sufficiently high relative to the effective overnight rate determined by the Fed.

That was the finding of BMO Capital Markets' monthly survey of investor intentions following the employment data. The share of investors that said they would buy if the jobs data caused yields to rise was 57%, compared with a six-month average of 47%. 

Next week also brings key inflation readings in the form of the March consumer price index. February CPI increases were bigger than estimated, spurring Treasury yields higher. Market-based inflation expectations have been rising with oil and gasoline futures prices; retail gasoline is a major component of the CPI.

--With assistance from Alice Gledhill.

(Adds Pimco economist comment and updates rates throughout; a previous version corrected the unemployment rate in second paragraph.)

More stories like this are available on bloomberg.com

Bloomberg News
Bonds Treasurys Federal Reserve
MORE FROM ASSET SECURITIZATION REPORT