by Michael Mackenzie and Ye Xie
Just when bond investors were doubting one of their favorite strategies, it’s making a comeback.
Treasuries surged on Friday as a surprisingly weak US payroll report unleashed a frenzy of buying following a month of bond losses. The data, including downward revisions that trimmed a whopping 258,000 jobs from the tallies in May and June, sent traders piling into fresh wagers on Federal Reserve interest-rate cuts. Overnight-indexed swaps signaled more than 80% odds of a reduction next month while fully pricing in one more cut by year-end.
“We’re now looking at a completely different labor market backdrop,” said Kevin Flanagan, head of fixed income strategy at WisdomTree Inc. “There’s nothing like a downward revision of a quarter million people to change the story.”
The shock factor of the data extended the rally across all maturities, but the major move was in the short end. Leading the action were rate-sensitive two-year notes, whose yields slid by more than a quarter point for their biggest one-day decline since December 2023. This led to a widening gap between yields on short- and long-dated debt, handing profits to anyone betting on the so-called steepening trend.
It’s a strategy that had largely been languishing since April, and it was a money-losing pain trade for much of July, causing many to unwind it. Playing a key part was the cost of financing the position: Because it’s expensive to maintain, a consistent steepening trend is needed to make holding such a wager worth it. But inconclusive economic data and uncertainties around tariffs left the market without a catalyst.
For those who stayed in the trade, or even reloaded in July, Friday was a vindication and potential prelude to further gains.
“We still like the steepening view and so are pleased to see the price action,” said Mark Dowding, chief investment officer of the BlueBay Fixed Income unit at RBC Global Asset Management, who is betting on a wider gap between yields on two- and 30-year debt.
On Friday, that spread had its biggest one-day rise since April 10, as traders rushed to reestablish positions that would favor a steepening yield curve under a scenario of Fed rate cuts. Futures volumes in early New York trading were running at around three times the usual and even greater in contracts that track policy expectations.
One notable trade was looking to benefit from multiple rate cuts this year, starting with a move at the next Fed meeting in September. That’s the kind of front-end trading action that rewards betting on a steeper or a more upward-sloping yield curve.
The rush into Treasuries on Friday — which also came amid a sharp slump in stocks and other risk assets — marked an abrupt turnabout from earlier last week, when bond traders spent much of their time cutting back their exposure, and wrapped up July with losses.
In particular, investors keyed in on a hawkish message Wednesday from Federal Reserve Chair Jerome Powell, who characterized the labor market as being “in balance” and preached patience in the face of still generally solid economic data and inflation that is running slightly hotter than the central bank would prefer.
“Powell basically ruled out a September rate cut — he gave the green light that you could be short at least the front end,” said Tony Farren, managing director in rates sales and trading at Mischler Financial Group. But the jobs number was so weak, investors were forced to cover their positions, he said.
The July jobs figures provide supporting evidence for those — including dissenting Fed Governors Christopher Waller and Michelle Bowman, not to mention US President Donald Trump — who believe the central bank should already be cutting rates by now. Meanwhile, Trump, who has stepped up pressure on Powell over his failure to cut rates, further rattled shaky markets on Friday by calling for the firing of the commissioner of the Bureau of Labor Statistics, accusing her of politicizing the employment report.
As the dust settles, traders will have to ascertain how much of Friday’s rally is a function of the negative sentiment that was weighing on Treasuries in the lead-up to the employment report. The challenge for bond bulls is whether the deteriorating jobs picture is a forewarning of a much weaker economy that would obviate the danger of higher tariff-induced inflation in the next few months.
And it’s only one number: Still ahead are two months of key economic data before the next Fed policy meeting, including a pair of inflation reports and another payroll reading.
The July jobs report “clearly increases the odds of a September cut, but it is not a done deal because unemployment is still low and we still have upside risks to inflation from a higher effective tariff rate,” said Priya Misra, portfolio manager at JPMorgan Investment Management. She said “greater tension” between softer employment and stickier inflation “could be a bumpy ride trying to price in the timing and pace of rate cuts.”
Misra prefers increasing overall bond exposure and “reducing some of the steepener in our portfolio to position for the stagflationary policy mix with tariffs and lower immigration.”
What Bloomberg strategists say ...
“Pain in terms of positions was evident, and that can have a domino effect. Asset managers were heavy buyers in Treasuries Friday. Government data shows this group had recently pared longs, a situation that’s likely now creating distress.”
— Alyce Andres, MLIV rates strategist. Read more here
Beyond the data, investors are bracing for a slew of Treasury debt at this week’s quarterly refunding, which may help to support the steepening trend. The government will sell $125 billion of securities, including a combined $67 billion of 10- and 30-year debt. The issuance could serve to elevate longer-term yields, already under pressure amid concern over fiscal debt and deficits.
“A bias toward curve steepeners could lift the 10-year yield back above 4.30% over the near-term,” particularly as markets position through the upcoming Treasury refunding auctions, said John Canavan, analyst at Oxford Economics.
The 10-year note edged up three basis points to 4.24% in Asian trading on Monday after sliding 16 basis points on Friday.
James Athey, a portfolio manager at Marlborough Investment Management Ltd., said he still holds steepener positions, but it may take time for the trend to progress further. More confirmation of slowing growth is needed, given the cross-currents with trade and inflation uncertainties. At the end of the day, though, he sees that data coming through, paving the way for rate cuts.
“Curves always bull-steepen if we get a proper rate-cutting cycle, which is what we expect,” Athey said.
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