(Bloomberg) -- US Treasuries rallied and traders boosted their bets on a Federal Reserve interest-rate reduction this month after a mixed November employment report.
Yields on two-year notes, which are sensitive to central-bank policy changes, slid as much as seven basis points to around 4.08% and retained the bulk of their drop late afternoon in New York, after the data showed that job creation and the unemployment rate both increased last month. Traders are pricing in an approximately 80% chance of another quarter-point easing at the Fed’s December meeting, up from 64% before the data.
“The data didn’t live up to the market’s worst fears, and the front end can remain supported as this report keeps the door open to a rate cut later this month,” said Kevin Flanagan, head of fixed income strategy at WisdomTree. “But there are limits along the curve as to how far the rally can go given what’s now priced in for the Fed.”
Treasuries held the bulk of their gains after the University of Michigan’s consumer sentiment gauge increased more than expected for December to the best reading in eight months. Respondents’ one-year inflation expectation rose more than forecast to 2.9%, the highest since July.
The jobs data unleashed a torrent of trading in short-term interest-rate futures. Volume in the January federal funds contract were around 480,000, a record for the tenor. Some traders — including via at least one large block — looked to back a rate cut at the Fed’s December policy meeting, while others exited short wagers on no rate change.
Mohamed El-Erian, president of Queens’ College, Cambridge and a Bloomberg Opinion columnist, said the unemployment rate increase “means the Fed will be comfortable cutting by 25 basis points.”
The US economy generated 227,000 new jobs last month compared with an anticipated gain of 220,000. The unemployment rate unexpectedly edged up to 4.2%, and wages grew 4% year-on-year, more than economists estimated.
What Bloomberg’s Strategists Say
“Investors viewed the report as Goldilocks for the bond market. Bonds rallied in relief that payrolls growth did not come in higher with more positive signs than negative ones and the whisper number climbing all week”
— Alyce Andres, macro strategist
For the full column, click here
Traders were also encouraged by the lack of a bigger upward revision to October employment, which was depressed by hurricanes and strikes. Also, the unrounded unemployment rate was 4.246%, narrowly missing an even larger increase.
The reading led economists at Citigroup Inc. to scrap their contrarian call for another big rate cut at the Fed’s meeting later this month.
“The report was not quite soft enough” for the Fed to cut a half point in December, Citigroup’s Andrew Hollenhorst and Veronica Clark wrote in a note. They now see a quarter-point cut in December as likely, with subsequent easing reaching a terminal rate of 3.00% to 3.25%.
To Priya Misra, portfolio manager at JP Morgan Asset Management, the data “should help the soft-landing narrative persist and explains why the curve is bull-steepening and risk assets are doing okay.”
Expectations that the Fed — which cut rates by a half-point in September and a quarter-point last month — will pause at some point to ensure inflation doesn’t reaccelerate have been mounting based on strong economic performance and the US presidential election.
The swaps market prices in a pause early next year, as it prices in fewer than 50 basis points of easing over three Fed decisions between now and the end of March.
“We are going to pivot to this pause-and-skip debate and what that kind of message means,” said Jeffrey Rosenberg, senior portfolio manager at BlackRock, on Bloomberg Television. “The bigger debate is the amount of rate cuts for 2025.”
Speaking Friday after the jobs data, Fed Governor Michelle Bowman said she favors lowering interest rates cautiously as underlying inflation remains “uncomfortably” above the central bank’s 2% goal.
Chicago Fed President Austan Goolsbee, also speaking Friday after the data, said the labor market appeared to be in a “sustainable, full employment kind of place” and declined to say whether he’ll support a December rate cut.
November inflation data to be released next week will also inform the Fed’s Dec. 18 decision. The growth rate of the consumer price index fell sharply from mid-2022 to mid-2023, but progress then slowed and the rate edged higher in October, to 2.6%.
“The road to a 2% inflation target is likely bumpy, to quote Powell, and if we get a sticky reading this will be a challenge for the Fed and the bond market,” WisdomTree’s Flanagan said.
--With assistance from Cristin Flanagan.
(Updates yields in second paragraph and futures volume in par 5)