Treasuries Surge as Wall Street Pressures the Fed to Ease Policy

Treasuries Surge as Wall Street Pressures the Fed to Ease Policy·Bloomberg
Liz Capo McCormick
4 min read
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(Bloomberg) -- A rally in the Treasury market accelerated on Friday as softening US employment data fueled speculation the Federal Reserve will start aggressively cutting interest rates to keep the economy from stalling.

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The policy-sensitive two-year Treasury yield tumbled as much as 31 basis points to 3.84%, the lowest since May 2023, before paring the drop. Rates on Treasuries of all maturities declined after data showed job growth slowed last month, kindling concern the US economy is at risk of decelerating into recession.

Traders are now pricing in expectations for more than a full percentage point of Fed rate cuts by year-end. With just three meetings left, that reflects the growing perception that the US central bank will need to make an unusually large half-point move at one of the gatherings or act between its scheduled meetings — moving rapidly to bolster growth.

“The market is starting to think the Fed is too late in cutting rates,” said Tony Farren, managing director in rates sales and trading at Mischler Financial Group.

Economists at several big Wall Street banks also adjusted their Fed forecasts after the data, and are now calling for earlier, bigger or more rate cuts.

The recalibration came after the Fed kept its target rate at a more than two-decade high at its policy meeting this week. While Fed Chair Jerome Powell telegraphed the central bank may ease policy at its next meeting, a rise in unemployment claims, weak manufacturing data and now the jobs data are rattling investors, sowing concern the central bank has waited too long.

Powell repeated on Wednesday that the Fed is relying on incoming data when setting policy and emphasized that policymakers are mindful of the risks of waiting too long.

“The soft landing narrative is now shifting to worries about a hard landing, and the market is increasing the odds that the Fed will have to make a 50 basis point cut in September,” said Lara Castleton, head of US portfolio construction and strategy at Janus Henderson Investors.

At Citigroup Inc., economists changed their forecast to reflect a Fed easing cycle that begins with 50-basis-point reductions in September and November. JPMorgan Chase & Co. also predicted half-point rate cuts in September and November.

Chicago Fed President Austan Goolsbee emphasized on Bloomberg Television that the central bank will not overreact to any one report, adding policymakers will get a lot of data prior to the Fed’s next meeting.

“The most likely outcome is relatively gradual rate cuts toward neutral, as opposed to the Fed really needing to accelerate cuts to support the economy,” said Kris Dawsey, head of economic research at the D.E. Shaw Group. “But that outcome can’t be ruled out either — it’s very plausible we may be talking about a 50 basis point cut at some point in the coming meetings.”

Dawsey predicted a further steepening of the yield curve, meaning a continued narrowing of the premium that short-term rates have above their long-term counterparts. The spread between two- and 10-year yields narrowed by around 8 basis points on Friday.

Tumbling US stock prices also sparked demand for Treasuries as a haven. The 30-year Treasury yield fell as much as 18 basis points to as low as 4.10%.

It bears mentioning that bond traders have jumped the gun on numerous occasions when it comes to pricing in rate cuts from the Fed, only to be caught offsides when the economy continued to exhibit surprising strength. That happened in late 2023, when traders expected rate cuts to start early this year.

But even before this week’s Fed meeting, former New York Fed President William Dudley and Mohamed El-Erian warned that the Fed was at risk of erring by holding rates too high for too long. Both were writing as Bloomberg Opinion columnists.

What Bloomberg strategists say...

“It looks like the market is jumping the gun on a recession that, if it does occur, is more likely to happen next year at the earliest.

The Sahm Rule has been triggered, no doubt fueling some recession angst. But as noted earlier, not only does it lag recessions and miss most of the equity downturn, it is neither a necessary nor sufficient condition for a recession. Moreover, today’s rise in unemployment was mainly driven by a rise in the participation rate.

— Simon White, rates strategist. Read more on MLIV.

--With assistance from Alice Atkins, Marcus Wong, David Finnerty, Sydney Maki, James Hirai, Ye Xie, Constantine Courcoulas, Neha D'silva, Tian Chen, Edward Bolingbroke, Anya Andrianova and Michael Mackenzie.

(Updates market pricing.)

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