(Bloomberg) -- US Treasuries are mostly sliding a day after the Federal Reserve cut interest rates by half a percentage point, with investors finding evidence of labor-market strength in the latest data.
Longer-dated US government debt slipped on Thursday after weekly initial jobless claims unexpectedly fell, indicating the job market remains healthy. Two-year notes, which are closely tied to monetary policy, meanwhile ticked higher in the wake of the Fed’s larger-than-expected rate reduction.
“For the Fed, it’s clear now that it’s all about the labor market as their main driver for monetary policy in the future,” said Danny Zaid, a portfolio manager at TwentyFour Asset Management. “Given that government bond yields have come down a lot in recent months, for us in fixed income, we see it as a very good environment for credit.”
While Fed rate cuts can be a balm for bonds, the market had completely priced in at least a quarter point. Fed Chair Jerome Powell on Wednesday also emphasized that future adjustments wouldn’t necessarily be as large, particularly in the face of a resilient labor market.
However, early action in the options market tied to the Secured Overnight Financing Rate — which closely follows monetary policy path — has so far reflected traders preparing in case of more-aggressive Fed easing. A standout trade, also seen Wednesday prior to the Fed’s announcement, has been a hedge on a policy rate as low as 1.25% by March — well below current market implied rate of roughly 3.5% by that time.
US government debt is still on course for a fifth-straight monthly gain, according to data compiled by Bloomberg, which would mark the best streak since 2010.
What Bloomberg strategists say...
“Bonds are still responding to the Federal Reserve’s large cut Wednesday. The pain trade for Treasury traders is squarely on the bear steepener, which is unsurprisingly extending today with the Fed likely to stick the soft landing.”
— Alyce Andres, US Rates/FX Strategist on MLIV.
It’s a recipe for volatility in the world’s biggest bond market as economic data — particularly for the labor market — influence expectations for the course of Fed policy. The 10-year Treasury yield, the risk-free benchmark that anchors more than $50 trillion in global dollar-denominated fixed-income securities, at around 3.75% is still down about a percentage point from this year’s peak in late April.
Swaps contracts for the outcome of future Fed policy meetings are pricing in another 70 basis points of easing by year-end — and around two percentage points of cuts by the end of next year. That’s more than the Fed’s dot plot of policymaker forecasts, which points to only another 50 basis points of easing this year.
Fed officials updated quarterly economic forecasts to raise their median projection for unemployment at the end of 2024 to 4.4%, from 4% in June. Powell said last month that further cooling in the labor market would be “unwelcome.” The upsized cut to kick off the cycle was Powell’s attempt at ensuring the soft landing he’s long had in his sights.
“It now will be a battle between market expectations and the Fed, with employment data — not inflation data — determining which side is right,” said Jack McIntyre, portfolio manager at Brandywine Global. “Since this policy move was mostly telegraphed, there is no outsized move in financial markets. Now, everyone is back to data dependency.”
Another big reduction hinges on the US labor market getting weaker, according to JPMorgan Chase & Co., a Wall Street titan whose economists correctly called the size of this week’s cut. They still expect a second straight half-point move come November. Goldman Sachs Group Inc. revised its forecasts to see a faster pace of cuts, and said the choice between a quarter- or half-point reduction next is “a close call.”
Philip Camporeale, portfolio manager at JPMorgan Asset Management, said the firm is not expecting a recession but sees US Treasuries as a good hedge against that unlikely outcome.
Treasuries are good “ballast” now, Camporeale said on Bloomberg Television Thursday. But “We do not expect yields to plunge.”
A gauge of the dollar reversed Wednesday’s move to slip 0.2%, with Norway’s krone leading gains after its central bank bucked the Fed’s easing drive to hold pat. The yen fell as the Bank of Japan started its two-day meeting, with economists unanimous there won’t be a policy change.
It’s been a hectic week for central bank meetings. The Bank of England on Thursday kept rates steady and warned investors it won’t rush to ease monetary policy, deciding against a second consecutive cut in borrowing costs as it awaits further signs inflationary pressures have subsided.
“For now, the Fed can afford to humor financial markets,” said Naomi Fink, Nikko Asset Management’s chief global strategist. “Wherever ‘neutral’ rates sit, they are lower than where we are now, allowing some additional room for the Fed to cut rates in the name of normalization, rather than outright stimulus. But the market appears to be keener on rate cuts than the Fed itself.”
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