Bond traders await May jobs data for Fed signals

by Ye Xie

Bond traders will dissect the May jobs report for any signs of a softening labor market as they gauge the timing of Federal Reserve interest-rate cuts.

Treasury yields briefly declined to the lowest levels in nearly a month on Thursday after weekly jobless claims unexpectedly jumped to the highest level in eight months, prompting traders to almost fully price in a rate cut by September, instead of October. While traders still see the Fed keeping borrowing costs steady later this month, any major surprises in Friday’s payroll data could push them to recalibrate.

“The Fed needs to see a significant deterioration in the labor market to cut interest rates this summer,” wrote Tim Duy, chief economist at SGH Macro Advisors. “The latest data, however, suggest that the labor market continues to soften but not collapse. Tomorrow’s May employment report could change the picture.”

Fed officials have said they are waiting for more data before lowering rates as they balance the risks of still elevated inflation and a potential economic slowdown. Officials have said it could take months to gain clarity on the economic impacts of sweeping policy changes, particularly around trade. 

Interest rate swaps showed that traders see about a 25% probability of the Fed lowering the rates by July after keeping them unchanged in a range between 4.25% and 4.5% at the June 17-18 meeting. The possibility of a reduction in September was around 90% and a total of two quarter-point rate cuts were fully priced in by year-end. 

This week’s economic data has painted a mixed picture of the job market amid the uncertainties of the Trump administration’s tariff wars. Private-sector payrolls showed hiring decelerated in May to the slowest pace in two years, while job openings unexpectedly rose in April.

Friday’s employment data is expected to show nonfarm payrolls increased by 125,000 in May, following a 177,000 jump a month earlier. Economists predict the unemployment rate to be unchanged at 4.2%. 

“The economy is tagging along with a bias toward some softness,” said Jack McIntyre, portfolio manager at Brandywine Global Investment Management, who is bullish on bonds. “If you short bonds, and if the Friday data comes in weak, then you run the risk of being caught. You can explain away a strong number as noise, more so than the weaker data.”

Policy-sensitive two-year yields steadied at 3.91%, after advancing about two basis points this week. Ten-year yields dropped as low as 4.31% on Thursday before a selloff in European government bonds pushed the rates up to 4.39%. The benchmark was little changed at 4.39% in Asia Friday.

Bond traders have been betting that short-term bonds would outperform longer-maturities – known as yield curve steepening. They are riding on the notion that the Fed will eventually reduce borrowing costs and drive short-term yields lower, while President Donald Trump’s proposed tax bill may worsen the US deficit and keep long-term borrowing costs higher.

Further curve steepening requires a rally in short-term notes, which requires more signs of a labor market slowdown, said Kelsey Berro, fixed-income portfolio manager at JPMorgan Asset Management. 

Copyright Bloomberg News