(Bloomberg) — For the first time in 18 months since the Federal Reserve began raising interest rates, the job market is showing enough cracks to prompt some of the world’s biggest bond investors to bet that the tightening cycle is at an end.
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This week’s flurry of delayed employment measures, highlighted by Friday’s August payrolls report, shifted market sentiment and made policy a focus for two-year Treasuries, which BlackRock Inc.’s Jeff Rosenberg called a “noise buy.”
Hopes that the Fed will end its most aggressive tightening campaign in decades have drawn investors to another popular end-of-cycle trade — the steep yield curve. As the bearish focus shifts to the timing of an easing potential Fed policy, short-maturity notes will fare better than longer-dated bonds. The strategy may also be benefiting from a seasonal trend: Companies typically rush to sell debt after the US Labor Day holiday, putting pressure on long-dated bonds.
The jobs data “contributes to the bond market’s view that the Fed is on hold for the time being and may be for the cycle,” said Michael Kuzil, portfolio manager at Pacific Investment Management Co., which oversees $1.8 trillion. “If you’ve done the cycle for the walk, it’s looking at the first cut that leads to the steepest curves.”
While inflation has eased in recent months, it remains the main obstacle for the Fed to end its hike by raising borrowing costs by 525 basis points to a range of 5.25%-5.5% from March 2022.
But now the Labor background seems to be cooling down. A government report showed Friday that the unemployment rate rose to 3.8%, a level seen at the end of February 2022, and wage growth moderated. The weaker-than-expected jobs market release was the third in a week and followed a report by the ADP Research Institute that showed job additions at US firms slowed.
Bond investors cheered the data after the 10-year yield hit its highest level since 2007 in August. The rate, a benchmark for global lending, dropped to a low of 4.2 percent for the week.
Bloomberg strategists say…
“While it would be a bit foolish at this point to completely write off the possibility of another rate hike, it doesn’t look like the Fed will have to go again at this point.” That opens a window of opportunity for bonds to rally nominally, although it’s an open question whether real earnings will be positive for the rest of the year.
– Cameron Crisis, Macro Man column
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Short-term Treasuries edged higher on Friday, pushing up the yield curve. The two-year yield fell roughly 20 basis points on the week to 4.9 percent. Meanwhile, 30-year yields were little changed around 4.30% on the week after rising above five-year yields for the first time in weeks.
Jorge Goncalves, head of US macro strategy at MUFG, said the employment reports looked like “the beginning of the end of a strong labor market and a countdown to how long the Fed can last.” “This supports the front-end of the back-end,” he said, adding that two-year yields could drop to 4.5%.
Interest-rate swing traders see a less than 50% chance of another hike in November. After that, they fully priced at a quarter-point discount in June.
As wage growth slows, Rosenberg, portfolio manager of BlackRock’s $7.4 billion multi-strategy fund, said the Fed should cut borrowing costs to avoid tightening the real rate — or inflation-adjusted policy rate.
“It’s a more restrictive policy, not a higher one,” he said on Bloomberg TV. “That’s what the bond market has priced in for next year. The gradual decline in inflation is not because the Fed is holding back on inflation or because they are too tight, but because it avoids excessive inflation to maintain limits.
Rosenberg said he favors two-year Treasuries because they both have higher yields and the potential to benefit from changes in federal policy. Long-term bonds are less attractive because there is uncertainty about inflation and a risk premium, he said.
Longer maturities fell on Friday as traders are bracing for more corporate emissions next week, said Subhadra Rajappa, head of US price strategy at Société Générale.
But the business curve is also supported by economic fundamentals, she said.
“The trade is high,” Rajappa said. “Either the market will start pricing in more Fed cuts and the curve will bull-slide, or the Fed will stop on strong data and in that case sell long.”
What should be seen
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Economic calendar:
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September 5: Factory orders; Durable goods orders; Capital goods orders
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September 6: MBA mortgage applications; trade balance; S&P Global US services and composite PMI; ISM services index; Fed beige book
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September 7: Non-farm productivity, unit labor costs; Unemployed claims
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September 8: Wholesale trade and goods; consumer credit; Family change in net price
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Federal calendar
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September 6: Boston Federation President Susan Collins; Dallas Federation President Lori Logan
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September 7: Philadelphia Federation President Patrick Hacker; Austin Golsbe, president of the Chicago Federation; NY Federation President John Williams; Federation Governor Michelle Bowman; Atlanta Federation President Rafael Bostick; Logan
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September 8: Federal Deputy Chairman of the Supervisory Board Michael Barr
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Auction Calendar:
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September 5: 13-, 26- and 52-week accounts; 42 days cash management account
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September 6: 17-week bills
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September 7: 4- and 8-week bills
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–Contributed by Katie Grefeld.
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