Bond Traders Reload Bets on Fed Cuts After Jolts

Treasury yields dropped sharply as data indicating a continued slowdown in the U.S. labor market fueled expectations that the Federal Reserve may soon cut interest rates. This movement in the bond market came just days before the release of a critical payrolls report, further highlighting concerns about the state of the economy.

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The latest report on job openings showed a decline that fell short of estimates, marking the lowest level seen since 2021. This data sparked a swift response in the bond market, with yields falling across the board. The decline was most pronounced in shorter-term maturities, which are more sensitive to potential changes in Fed policy. As a result, markets began pricing in additional rate cuts by the Federal Reserve in 2024.

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Chris Larkin of E*Trade from Morgan Stanley commented on the market’s reaction, noting that while there is less anxiety compared to a month ago, investors are still seeking reassurance that the economy isn’t slowing down too much. "The markets may not be as nervous as they were a month ago, but they’re still looking for confirmation the economy isn’t cooling off too much,” Larkin said. “So far this week, they haven’t gotten it."

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Looking ahead to Friday, the August jobs report is anticipated to show an increase of about 165,000 in payrolls, according to a Bloomberg survey of economists. Although this figure is higher than the modest 114,000 gain reported in July, it still suggests a slowdown in job growth. The average payroll growth over the past three months would decline to just over 150,000, which is the slowest pace since early 2021.

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In response to the labor market data, the yield on 10-year Treasury notes fell by five basis points to 3.78%, while the dollar weakened. The S&P 500 showed little movement overall, though Nvidia Corp. managed to recover from earlier session lows.

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Meanwhile, Bank of America Corp. reported that its clients were net sellers of U.S. equities for the second consecutive week, marking the largest net sale of shares since late 2020. Institutional investors, hedge funds, and retail clients collectively sold $8 billion worth of U.S. stocks in the week ending August 30, according to quantitative strategists led by Jill Carey Hall. The technology sector saw the largest outflows, with significant selling following Nvidia’s recent earnings report.

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Solita Marcelli of UBS Global Wealth Management offered a broader perspective on the stock market, predicting that equities could trade higher over the next 6 to 12 months. However, she also warned of potential volatility in the near term. "We expect stocks to trade higher over the coming 6-12 months but would not rule out renewed volatility in stocks in the near term,” Marcelli said. She added that September has historically been a challenging month for stock market returns, suggesting that seasonal factors might be contributing to the current negative sentiment.

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In summary, the recent slowdown in the U.S. labor market has intensified expectations for Federal Reserve rate cuts, leading to a significant drop in Treasury yields. Investors are closely watching for further signs of economic cooling, particularly with the upcoming August jobs report. While there is cautious optimism about the longer-term outlook for stocks, concerns about short-term volatility remain, especially given the historical trends associated with September.

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