(Bloomberg) — The world’s biggest bond market is back in celebration mode after its worst month in more than a year.
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Evidence that the US labor market is finally softening in response to the Federal Reserve’s interest-rate increases revived bets that the central bank will begin lowering rates by the end of the year. That enabled the bond market to extend a rally that began Wednesday after supportive comments by Fed boss Jerome Powell.
While the gains have faded somewhat ahead of next week’s Treasury note and bond auctions, yields remain lower for a third straight day. The two-year note’s yield has fallen more than 20 basis points since Tuesday, its biggest decline over a three-day period since January.
“Today’s jobs report, though it wasn’t a disaster, further confirmed to the Fed that monetary policy is restrictive,” said Priya Misra, a portfolio manager at J.P. Morgan Asset Management. “All of this keeps the cuts narrative alive, and it’s positive for both Treasuries and risk assets. There’s room for rates to fall further, and if the next consumer price report shows moderation, then this thing is really going to run.”
The US consumer price index for April is slated to be released on May 15.
The bond market has been punished for most of this year by inflation readings that failed to moderate as much as the Fed expected. Yields reached their highest levels of the year in the past two weeks on indications that economic growth also remains robust.
Expectations for Fed rate cuts — which traders at the start of the year wagered would total at least 150 basis points — dwindled nearly to a single, 25-basis-point cut, and not until December.
The US government’s April employment report brought a reprieve. Job creation slowed to 175,000, the smallest gain in six months, the unemployment unexpectedly rose to 3.9% and wage gains slowed.
In response, derivative traders resumed mostly pricing in a Fed rate cut in September and two quarter-point moves this year. The two-year Treasury note’s yield, more sensitive than longer maturities to changes in the Fed’s rate, fell as much as 17 basis points to 4.71% before rebounding to around 4.81%. It peaked at 5.04% this week.
Bonds’ recovery began after Powell in the news conference after the Fed’s most recent policy meeting downplayed the chances that the central bank would resume raising rates.
Treasury yield of all maturities remain at least five basis points lower on the day, some near the lowest levels since mid-April. The market’s 2.3% loss in April, as measured by the Bloomberg Treasury Index, was its biggest in more than a year.
Friday’s rally may have been aided by investors scrapping positions that anticipated yields would continue to rise, in addition to the establishment of new positions predicated on further yield declines. Transactions included several large block trades in short-term interest rate futures, used by traders to wager on the outlook for Fed policy.
The jobs data “should be perceived by markets as a welcome breath of fresh air as it will hush the hawkish undertone in the market and any recent stagflation fears,” said Alexandra Wilson-Elizondo, co-CIO of multi asset solutions at Goldman Sachs Asset Management. “We continue to look through the debate around timing of cuts to the fact that the data, in aggregate and observed over a longer time period, will drive a non-recessionary cutting cycle. This should be positive for risk assets and bonds.”
The S&P 500 index was up almost 1% as investors saw an economy still strong enough to support earnings as well as prospects that lower rates would also work as a tailwind ahead.
Read more: Extreme Bond Market Shorts Gamble on a Hawkish Powell Pivot
US interest-rate volatility remains elevated and is expected to remain high as each new piece of economic data has the potential to alter expectations for Fed policy. Swaps traders this year have priced in as many as six and as few as one quarter-point Fed cuts in 2024.
The ICE BofA MOVE Index — a gauge of bond volatility that tracks anticipated swings in Treasury yields based on options — has averaged about 106 so far this year versus 77 over the past decade.
“The April payroll report was unambiguously positive for the rates market,” said Gennadiy Goldberg, head of US interest rates strategy at TD Securities. “It plays right into Powell’s pushback on rate hike expectations, which suggested the market was getting ahead of itself on hawkishness. But the market will continue to lurch from data point to data point as investors refine the odds of cuts in 2024.”
–With assistance from Edward Bolingbroke.
(Adds comments and context and updates yield levels throughout.)
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