Treasuries Rally, Fed Cuts Seen by Dec, After Jobs Disappoint

Key Takeaway

• Treasuries surged as traders anticipate the Fed to start cutting rates as early as September, following a disappointing US jobs report.
• Two-year Treasury yields dropped 17 basis points to 4.71%, indicating increased expectations for softer monetary policy.
• Market now prices in two 25 basis point rate cuts by year-end, adjusting from previous expectations set for November.

Fed Rate Cut Expectations Surge

Following a US labor-market report that fell short of estimates, traders have significantly adjusted their expectations for the Federal Reserve's monetary policy, anticipating rate cuts sooner than previously expected. The benchmark two-year Treasury yields, which are closely linked to Fed policy outlooks, saw a sharp decline of up to 17 basis points, dropping to 4.71%. This adjustment in expectations has brought forward the timing of the anticipated rate cuts, with traders now foreseeing a potential cut as early as September, a notable shift from the previous November projection. The market is now pricing in two 25 basis point reductions within this year, indicating a rapid change in sentiment towards a more dovish Fed stance.

Bond Rally and Market Reaction

The surge in US Treasury bonds was catalyzed by comments from US central bank chairman Jerome Powell, which were interpreted as dovish by the market. This led to the most significant two-day drop in two-year yields since January, highlighting the market's sensitivity to Fed communication and economic indicators. The nonfarm payroll figures, which came in at 175k versus the 240k forecast, further fueled this bond rally. The unexpected rise in unemployment to 3.9% from 3.8% also played a crucial role, suggesting a weaker labor market than anticipated and bolstering the case for earlier and more aggressive rate cuts by the Fed.

Currency and Stock Market Implications

The bond rally and adjusted Fed rate cut expectations had immediate implications for other financial markets. The dollar weakened, particularly against the yen, which strengthened to 152 per dollar following the jobs report. Stock futures also saw a surge, indicating a positive reaction from equity markets to the prospect of lower interest rates. This multifaceted market response underscores the interconnectedness of bond, currency, and stock markets, with shifts in monetary policy expectations quickly reverberating across different asset classes.

Street Views

• Mohamed El-Erian, Queens’ College, Cambridge (Neutral on the market and Fed policy):

  "It’s a Goldilocks report that will please the Fed and please the market."