Bond traders, who fueled a robust rally in the $26 trillion US Treasury market, are on the verge of a reality check as they await Friday’s crucial jobs report. Recent data indicating softening inflation and employment figures have led investors to believe that the Federal Reserve has halted interest rate hikes, sparking expectations of potential cuts exceeding 1.25 percentage points over the next year. Consequently, Treasury yields, which touched 5% in October, have significantly retreated, with the US 10-year benchmark dropping more than three-quarters of a percentage point.
As the market anticipates the US labor market report on Friday, optimism among bulls hinges on signs of a cooling economy. Bond markets are already pricing in more than double the amount of monetary easing in 2024 compared to the Fed’s own projections. However, despite the cautious stance from Fed officials, traders remain undeterred, maintaining their largest net long positions since November 13, according to a JPMorgan Chase & Co. survey.
The forthcoming report is expected to reveal moderated employment and wage growth in November, with potential risks of a market reversal, at least initially, if the data challenges traders’ bullish narrative amid the recent bond rally.
Kevin Flanagan, head of fixed-income strategy at WisdomTree, emphasizes the need for validation of the Treasury rally, stating, “The bar has been raised now in terms of the economic and inflation numbers coming in, and they’re going to have to show that the momentum of a slowdown is picking up.”
Economists project payroll growth of 185,000 for November, following a 150,000 increase in October, while the unemployment rate is expected to remain steady at 3.9%. The end of strikes in the auto and entertainment industries is likely to boost payrolls after a slump in October, potentially masking an underlying slowdown in the pace of payroll gains.
A robust jobs report could provide the Fed with justification to avoid prematurely cutting rates and highlight concerns of the bond market being ahead of the central bank. John Brady, managing director at RJ O’Brien, notes that with the 10-year yield below 4.2%, the market appears to be priced for a significant near-term deterioration.
As the Federal Reserve enters its quiet period before next week’s policy meeting, the central bank will assess the latest economic projections and interest rate paths, taking into account the jobs and inflation reports. Market observers anticipate the Fed to maintain its current policy, with expectations pointing towards a potential rate cut as the next move.
Bank of America’s chief US economist, Michael Gapen, anticipates a dovish shift from the Fed, expecting officials to project three rate cuts for 2024 in the upcoming economic projections. The bond market, currently priced for deep cuts in early 2024, may face a shock if the Fed signals a more cautious stance.
