Bond traders are turning to labor market data to bet on a big Fed cut

(Bloomberg) — Bond traders are turning to Friday's jobs report for clues about the health of the U.S. economy as belief over a second major interest rate cut by the Federal Reserve this year falters.

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U.S. Treasury bonds fell this week and money markets tempered expectations of another half-percentage point rate cut in November or December after Chairman Jerome Powell said the economy was on strong footing. Pricing now implies just a 30% chance of 50 basis points next month, down from 60% a week ago.

That raises the stakes ahead of the release of September employment data, which is expected to show a rise in payrolls. Any signs of weakness in the labor market are likely to revive the recent rally in U.S. Treasury bonds and raise expectations of another big cut. Policymakers surprised many investors when they began their easing cycle with a half-percentage point cut last month.

Significant weakness in September jobs data “would cause us to turn more toward the bond market,” said Jeff Given, senior portfolio manager at Manulife Investment Management, which has reduced its exposure to market rates. Still, he believes quarter-point rate cuts in November and December are “the most likely scenario” and “what Powell hinted at this week.”

The yield on two-year Treasury bonds – the most sensitive to changes in monetary policy – was steady at around 3.70%, 20 basis points above this year's low of 3.50%. The benchmark 10-year yield was around 3.83%.

This week's economic data suggests the economy remains on solid footing. Private-sector job growth and a measure for the services sector were stronger than expected, and new jobless claims did not indicate layoffs. Powell also reiterated his comment this week that policymakers were in no hurry to make further rate cuts.

Economists expect September's jobs report, due out at 8:30 a.m. in Washington, to show a 150,000 increase in the number of employed people, more than in any of the previous three months, according to a Bloomberg survey. The unemployment rate in the US is expected to remain at 4.2%. The July figure of 4.3% was the highest so far this year.

The jobs data is crucial as Fed officials have said they may pay more attention to risks to the labor market as inflation returns toward its long-term 2% target.

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While weaker-than-expected job growth could increase the chances of a half-percentage point rate cut again in November, the impact of labor strikes at Boeing Co. and U.S. Eastern and Gulf ports, as well as Hurricane Helene, could complicate the analysis. October employment data is expected to be released on November 1, before the Fed meets.

“At some point this game between the market and the Fed is going to reach its climax,” Jack Manley, global markets strategist at JPMorgan Investment Management, told Bloomberg Television on Thursday. He said September job growth numbers expected would push the prospects for cumulative rate cuts in the final two sessions of this year closer to 50 basis points.

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