On Monday, U.S. Treasury prices across all maturities plummeted, exacerbating the bond trading collapse triggered by strong labor market data, pushing the U.S. Treasury yield curve significantly higher (U.S. Treasury yield movements are inversely related to price movements). The latest release of incredibly strong U.S. non-farm employment data, along with an unexpected drop in the unemployment rate, led U.S. Treasury traders to significantly reduce their bets on the Federal Reserve continuing to cut rates by 50 basis points.
As most global bond traders abandon their bullish bets on U.S. Treasuries at least in the short term, the 10-year U.S. Treasury yield, known as the "anchor of global asset pricing," rose to its highest level since August, breaking through the key U.S. Treasury yield threshold of 4%. For the first time since August 1st, the interest rate futures market priced in a Federal Reserve benchmark rate cut of less than 50 basis points by the end of the year, implying that some traders are even pricing in the possibility of the Federal Reserve choosing not to cut rates at the November or December FOMC meetings.
From a theoretical perspective, the 10-year U.S. Treasury yield is equivalent to the risk-free interest rate indicator \( r \) in the denominator of the DCF valuation model, an important valuation model in the stock market. With other indicators (especially cash flow expectations in the numerator) not showing significant changes, and even the possibility of a downward bias in the numerator during the October U.S. earnings season, the higher the denominator level or the longer it operates at historical highs, the valuation of risk assets such as high-valued U.S. technology stocks, high-risk corporate bonds, and cryptocurrencies faces a contraction.
Traders now believe that there is an 85% chance that the Federal Reserve will shift to a 25 basis point rate cut in November. In contrast, before the non-farm employment report was released, the bond market's bets on a 25 basis point rate cut barely exceeded 50%, and the probability of a 50 basis point rate cut was once higher than that of 25 basis points.
Jane Nevruz, an interest rate market strategist at TD Securities, said: "The focus of the market discussion is even shifting towards whether there will be continued rate cuts." "From an economic perspective, the situation is not so bad, leading the market to reprice the Federal Reserve's rate cut path." TD Bank continues to expect the Federal Reserve to choose a 25 basis point rate cut in November, rather than continuing to insist on a 50 basis point rate cut.
Traders withdraw their bets on the Federal Reserve's path of substantial rate cuts - the non-farm employment data rebound forces traders to readjust their rate cut bets.
The 10-year U.S. Treasury yield rose by 6 basis points to 4.03% as of Monday's trading session, and the 2-year U.S. Treasury yield, which is more sensitive to rate expectations, rose by 10 basis points to 4.02%. The poor performance of short-term U.S. Treasuries with maturities of 2 years and below marks a temporary reversal of a key part of the U.S. Treasury yield curve trend, highlighting a significant cooling of the bond market's expectations for the Federal Reserve's future rate cut path. Historically, the U.S. Treasury yield curve is usually upward sloping, with higher yields for longer-term bonds; however, this norm has been interrupted for nearly two years due to the Federal Reserve's aggressive rate cut cycle.
These latest betting moves reflect the bond market's revived expectations for the Federal Reserve to lead a "no landing" scenario for the U.S. economy - that is, a situation where U.S. employment and the overall economy continue to grow, inflation rates rise again, and the Federal Reserve has little room for rate cuts. The incredibly hot non-farm employment report released on Friday once again sparked concerns about the U.S. economy overheating, undermining the U.S. Treasury's five-month upward momentum.
It is understood that the data released by the U.S. government on Friday shows that after the non-farm employment numbers for the previous two months were revised upward by 72,000, the non-farm employment numbers for September significantly exceeded expectations by adding 254,000 jobs, the largest non-farm job increase in six months. In contrast, the median expectation of economists was only 150,000, and the latest non-farm numbers exceeded the most optimistic expectations shown by media surveys. According to another set of data released by the U.S. Bureau of Labor Statistics on Friday, the unemployment rate unexpectedly fell to 4.1%, and average hourly earnings grew by 0.4% month-on-month, both figures exceeding economists' expectations (4.2% for the unemployment rate expectation and 0.3% for average hourly earnings growth).
Combined with other data released last week, it shows that U.S. companies still have a healthy demand for workers, and the number of layoffs remains very low. Coupled with earlier economic data showing the resilience of the U.S. economy, the non-farm employment report may significantly alleviate economists' concerns about the U.S. labor market cooling too quickly and the fear of economic recession. The situation in the U.S. labor market is closely related to U.S. consumer spending, and the scale of employment and earnings are crucial for overall consumption. The resilience of consumer spending will undoubtedly strongly drive the U.S. economic juggernaut to continue sailing, after all, 70%-80% of the U.S. GDP components are closely related to consumption."We had anticipated a potentially steeper yield curve, but also expected a gradual adjustment process," Goldman Sachs strategists, including George Cole, wrote in a report. "The strength in the September non-farm payrolls report may have accelerated this process, reigniting debates on the degree of monetary policy restraint, which in turn could deepen the Fed's rate cut in response to the perceived hit to the U.S. economy."
Open interest statistics for Monday (tracking positions in the futures market) dropped significantly in several contracts related to the Secured Overnight Financing Rate (SOFR), indicating that U.S. Treasury bulls are throwing in the towel. Meanwhile, in the hotter options market, a new batch of "Fed hawkish hedge" trades has emerged, betting that the Fed will only cut rates by another 25 basis points this year—implying that one of the next two meetings may opt not to cut rates.
Citigroup's team of economists, it is understood, said in a report on Monday that they expect the Fed to cut rates by 25 basis points in November, rather than the 50 basis points the group had previously expected. After the September non-farm payrolls data released on Friday suggested that the U.S. economy remains strong, Citi joined other Wall Street banks in abandoning the aggressive forecast of a 50 basis point rate cut.
"The bar for the Fed to stand pat in November is quite high, as one month of labor market data does not convincingly reduce the economic downside risks that have persisted for several months, and many datasets have pushed Fed officials to choose a 50 basis point rate cut in September," Citigroup economists Veronica Clark and Andrew Hollenhorst wrote in the report. "We believe that labor market weakness will re-emerge in the coming months, and the overall inflation trend will continue to slow, which may prompt Fed officials to choose a 50 basis point rate cut in December."
Traders are now anxiously awaiting a series of speeches by several Fed officials this week to gain further insight into the direction of interest rates. They are also waiting for U.S. inflation data to be released later this week, with economists widely expecting the U.S. Consumer Price Index (CPI) to rise by 0.1% in September, possibly the smallest increase in three months. Fed Chairman Jerome Powell recently emphasized that the rate dot plot forecasts published by Fed officials, combined with their September policy rate decision, indicate that the Fed will choose to cut rates by 25 basis points at the last two FOMC meetings this year, for a total of 50 basis points of rate cuts.
TS Lombard Managing Director Dario Perkins said, "The Fed does not need a recession to achieve a tolerable target level of inflation, so the Fed has chosen to ease monetary policy without waiting for real economic weakness." "So far, everyone should realize that the Fed is preemptively choosing to cut rates, and it will not stop immediately."
"In our view, the possibility of a 50 basis point rate cut at the Fed's FOMC meeting in November no longer exists. The U.S. bond trading market is still constantly adapting to the new pricing reality," the Bloomberg strategists' team of economists said.