U.S. Treasury yields took a notable dive following fresh data that signaled a slowdown in the labor market, fueling growing expectations among Wall Street investors that the Federal Reserve may implement significant rate cuts before the year ends.
A report showing a decline in job openings to their lowest level since 2021 triggered a swift response in the bond market, with yields tumbling, particularly in shorter-term maturities. Traders quickly recalibrated, pricing in over 100 basis points of Fed rate cuts, including the possibility of a sizable reduction. In a key shift, a segment of the yield curve momentarily reverted to a positive spread, signaling that some traders believe the economy may be approaching a downturn. This “disinversion” reflects the restored, albeit brief, normal relationship between two- and 10-year yields, which many investors use as a recession indicator.
“The markets may not be as jittery as they were last month, but there’s still significant focus on data to confirm whether the economy is cooling off too much,” said Chris Larkin from E*Trade, part of Morgan Stanley. “So far, the market hasn’t seen the confirmation it’s looking for.”
As the Fed approaches the start of its anticipated rate-cutting cycle, the main question on investors’ minds is: how large will the first cut be? This Friday’s upcoming employment report will likely provide a critical clue.
The previous jobs report heightened concerns about the U.S. economic outlook, prompting fears of slower growth. Fed Chair Jerome Powell has shifted the central bank’s focus toward risks in the labor market, moving beyond inflation as the primary concern. A weaker-than-expected report on Friday could further justify a more aggressive rate cut.
“Market sentiment suggests September is a toss-up between a 25- and 50-basis point cut,” said Neil Dutta, head of Renaissance Macro Research. “Opting for 25 basis points risks repeating the market dynamics we saw after skipping a hike in July. That choice might be okay for now, but the next data release could lead investors to think the Fed is behind the curve. They should take a 50-point cut while they can, rather than when they have to.”
Yields on 10-year Treasuries dipped by four basis points to 3.79%, and the U.S. dollar pulled back slightly. The S&P 500 remained volatile, while Nvidia Corp. recovered after a rocky start to September.
The Japanese yen advanced 1%, while the Canadian dollar lagged behind other major currencies following the Bank of Canada’s decision to cut rates, with the central bank hinting that further easing could come if inflation continues to decelerate.
“Any sign of labor market weakness will have a big impact on rate-cut expectations, as Powell remains highly focused on employment data. This makes the reaction to Friday’s payrolls data all the more crucial,” said Dennis DeBusschere of 22V Research.
This week’s key data point will be the August jobs report, with economists predicting a 165,000 increase in payrolls, up from 114,000 in July. However, despite this projected uptick, the average growth rate for payrolls over the last three months is expected to fall to just over 150,000, the lowest level since early 2021. Krishna Guha from Evercore noted that while job openings have softened, the overall labor market has not shown any dramatic signs of deterioration.
“The low level of layoffs and a slight uptick in hires suggest that the labor market remains resilient,” said Guha. “Friday’s employment report will determine whether the Fed goes with a 50-basis-point cut right away or opts for a smaller move.”
A weaker jobs report could be the tipping point for a stock market correction, according to Scott Rubner of Goldman Sachs Group Inc.
“Systematic funds like Commodity Trading Advisers are now leaning towards the downside over the next month,” Rubner wrote, cautioning that this could be the last week of strong, emotionless demand. Bank of America’s clients have also been net sellers of U.S. stocks for two consecutive weeks, with total net sales reaching $8 billion, the largest since late 2020, as economic uncertainty grows.
Bond market volatility is also rising in the U.S., with a measure of rate-market swings hitting its highest point since July 2023. By contrast, European rate volatility has remained relatively stable, as the European Central Bank is widely expected to cut rates by a quarter-point.
Kristina Hooper of Invesco anticipates that the Fed will start with a 25-basis-point rate cut, but this could be the beginning of a much broader easing cycle.
Citigroup strategists have noted that the risk/reward ratio is favorable for positioning in U.S. rates via payer options, given current market dynamics. “The most recent data doesn’t suggest a significant weakening in activity, but there’s still room for yields to move higher,” said Jabaz Mathai and Jason Williams from Citigroup.
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