Fed Rate-Cut Exuberance Ebbs After Jobs Data, Boosting US Yields

(Bloomberg) -- Treasury yields surged as traders pared expectations for the Federal Reserve to ease monetary policy aggressively next year after a better-than-forecast jobs report.

Benchmark two-year yields, those most closely tied to the outlook for US central-bank policy, rose as much as 14 basis points, the most in a day since June. Rates across the maturity spectrum were higher by at least about six basis points on the day. 

Swaps traders scaled back bets on how much the Fed will cut rates next year, pricing in about 110 basis points of easing, down from more than 120 basis points. The employment report said nonfarm payrolls increased by 199,000 last month versus economists’ 185,000 median estimate while the unemployment rate unexpectedly fell to 3.7% as workforce participation edged up.

“This is a good report,” Michael Darda, chief economist at Roth MKM said on Bloomberg Television. “The Fed is going to look at it and not really feel compelled at all that they need to embrace these early rate cuts next year that the market has priced in.”

Friday’s re-pricing vindicated strategists who’d said the bond market was running too far ahead of the central bank by pricing in rate cuts beginning as soon as March. Swaps traders Friday dimmed to about 40% the probability that the Fed lowers rates in March, from over 50% prior to the report.

Trading flows contributing to the shift included several large futures block trades in contracts on the two-year Treasury note contract and the Secured Overnight Financing Rate, a market rate influenced by the Fed’s rate. 

Read more: Bond Traders Racing Ahead of Fed Face Reality Check on Jobs 

In Europe too traders pared bets on interest-rate cuts next year. Five quarter-point reductions are still fully priced, and the odds of a sixth one are gradually slipping. The chance of a first move in March decreased slightly to 60% from 72% on Thursday.

“The report will stop people from talking about rate cuts,” said Gang Hu, managing partner at Winshore Capital Partners. “The trend of the labor market is weakening, but not as weak as people thought it’d be,” while inflation also doesn’t support easing, Hu said.

Safe to Buy

Yields for many Treasury tenors had declined to the lowest levels in several months earlier this week on the view that, even if rate cuts come later than expected, it’s safe to buy bonds as long as the most aggressive tightening cycle in decades is over. The Fed has raised interest rates by more 5.25 percentage points since March 2022 in response to quickening inflation.

Investors polled weekly by JPMorgan Chase & Co. have a net long position in Treasuries that matches the biggest ones on record since 2010. The market’s 3.5% gain in November was its biggest since 2008, wiping out a year-to-date loss through October.

Rick Rieder, BlackRock Inc.’s chief investment officer of global fixed income, said Friday that he favors buying debt maturing in three to seven years, expecting yields will decline as the Fed begins cutting rates, probably around June.

The Fed’s final policy meeting of the year is ahead next week, and while no change in rates is expected, officials Wednesday will update their projections — in what’s known as the dot plot — for the coming years for the first time since September. Then, the median forecasts anticipated one more quarter-point hike in 2023 followed by two cuts in 2024. Post-meeting comments by Chair Jerome Powell may further influence market pricing.  

“It’s probably the case that most Committee participants don’t want to encourage market expectations for easing in the next few months,” JPMorgan Chase & Co.’s chief US economist Michael Feroli said in a note. “Even so, the revisions to the economic forecasts will likely show lower core inflation this year and next, so we think the dots will still show some easing” with the median 2024 forecast moving down to 4.875% from 5.125% in September.

Feroli expects the Fed to keep its policy rate unchanged next week, holding in the current range of of 5.25% to 5.5%.

Read more: Fed Dot Plot Offers Clues on Appropriate Pace of Change

The day before the Fed decision, the government will release inflation readings for November, where the main rate is expected to ebb to 3.1% from 3.2%. A bigger-than-anticipated decline in October helped ignite last month’s massive bond rally.  

In addition, scheduled auctions of three-, 10- and 30-year Treasuries next week on Monday and Tuesday create supply pressure that may temporarily discourage buyers.

The shift in rate-cut expectations is a setback, “but we think people will buy the dip,” said Priya Misra, portfolio manager at JP Morgan Investment Management. “Not many had the opportunity to buy 10-year Treasuries at 5%, but even 4.25% is not a bad level heading into a slowing growth and inflation world.”

--With assistance from Aline Oyamada, Ye Xie and Michael Mackenzie.

(Updates yields, adds economist’s comment.)

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