Treasuries Rally as Mixed Jobs Data Fuels December Fed Cut Bets

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(Bloomberg) — U.S. Treasuries rose and traders boosted their bets on a Federal Reserve rate cut this month after a mixed November employment report.

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The yield on two-year bonds, which are considered sensitive to changes in central bank policy, fell seven basis points to 4.08% after data showed job creation and the unemployment rate increased last month. Traders are pricing in monetary easing of about 20 basis points at the Fed’s December meeting, up from about 16 basis points before the data.

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“The data fell short of the market’s worst fears, and the front end could remain supported as this report keeps the door open for a rate cut later this month,” said Kevin Flanagan, head of fixed income strategy at WisdomTree. “But there are limits along the curve as to how far the rally can go given what the Fed is now pricing in.”

The data unleashed a torrent of trading in short-term interest rate futures. Federal funds contract volume for January exceeded 300,000, a record for the duration. Some traders – including across at least one large bloc – are looking to support a rate cut at the Fed’s December policy meeting, while others exit short bets on no rate change.

The previous daily record for trading volume was set on November 14, when comments from Federal Reserve Chair Jerome Powell cooled expectations for a December interest rate cut.

Market odds for a quarter-point interest rate on December 18 have risen to around 80%, while expectations through the end of next year have risen to around 92 basis points of easing.

Mohamed El-Erian, president of Queen’s College in Cambridge and a Bloomberg columnist, said the unemployment rate increase “means the Fed will be comfortable with a 25 basis point cut.”

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The US economy created 227,000 new jobs last month compared to an expected increase of 220,000 jobs. The unemployment rate rose unexpectedly to 4.2%, and wages rose 4% year over year, more than economists estimated.

What Bloomberg Strategists Say

“Investors viewed the report as moderate for the bond market. Bonds rose on relief that payroll growth did not come in higher with more positive signs than negative ones and the number whispered higher throughout the week.

—Alice Andres, macroeconomic strategist

For the full column, click here

Traders were also encouraged by the lack of a larger upward revision to the October employment report, which was lowered by hurricanes and strikes. Also, the unrounded unemployment rate was 4.246%, which narrowly misses a larger increase.

The data “should help continue the soft landing narrative and explain why the curve is steepening and risk assets are doing well,” said Priya Misra, portfolio manager at JPMorgan Asset Management.

The Fed’s December interest rate decision remains subject to November inflation data to be released next week. The CPI growth rate fell sharply from mid-2022 to mid-2023, but progress then slowed and the rate rose in October to 2.6%. Excluding food and energy, the rate stabilized at 3.3%.

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“The road to the 2% inflation target is likely to be bumpy,” said WisdomTree’s Flanagan, “and if we get a flat reading it will be a challenge for the Fed and the bond market.”

Powell and other central bank officials said this week that the economy has been beating expectations since September, allowing them to take a measured approach in cutting the interest rate from a level they consider still restrictive to neutral. Additional comments are not expected before the December 17-18 meeting, as policymakers observe a calm period beginning this weekend.

(Adds strategist and investor comments, context and updates return levels.)

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