US Treasuries rallied significantly after the release of a weaker-than-expected July employment report, leading traders to reduce expectations for Federal Reserve interest-rate hikes. This resulted in the largest weekly gain in short-term maturities since May.
Two-year yields, which are highly sensitive to Federal Reserve policy expectations, fell by as much as nine basis points following the report, eventually settling about five basis points lower at around 4.19%. This marked the most substantial weekly decline since May. Meanwhile, benchmark 10-year yields decreased by approximately nine basis points for the week, settling at 4.65%, marking their first weekly decline in three weeks.
The Bureau of Labor Statistics reported a decrease of 23,000 in nonfarm payrolls for July, following significant downward revisions for the previous two months. This unexpected decline in employment figures has led to a reassessment of the labor market's strength, which had previously bolstered investor expectations for Fed rate hikes.
“The headline number being negative is a total shock.”
Tom di Galoma, Managing Director at Mischler Financial Group
Traders are now pricing in a roughly 40% chance of a rate hike at the Federal Reserve's next meeting in September, down from nearly 60% before the employment data release. In the options market linked to the Secured Overnight Financing Rate, traders are unwinding hedges against scenarios involving two rate hikes by the end of the year.
Despite the negative headline figure, some analysts caution against overreacting to the latest employment data. A team from TD Securities noted that while the data suggests a softer labor market, the overall trend remains healthy. Additionally, Fed Chairman Kevin Warsh's decision not to provide forward guidance adds complexity to market responses.
“I would be hesitant to write this report off as the revisions in the headline number are pointing to weakness.”
Jeffrey Rosenberg, Senior Portfolio Manager at BlackRock
Background
The US labor market had shown surprising strength earlier in the year, fueling expectations for Federal Reserve rate hikes. However, the recent employment data suggests potential challenges, leading to a reassessment of these expectations.
Looking ahead, the next major economic data release will be the US consumer price index figures, due on Wednesday. Rising energy prices due to geopolitical tensions have reignited inflation concerns, but a softer-than-expected CPI print last month helped ease some of those worries. Analysts suggest that if inflation data continues to show softness, the Federal Reserve may hold off on further rate hikes.
