Treasuries Rally as Powell Bets on Rate Cuts in September

U.S. Treasury bonds surged following Federal Reserve Chair Jerome Powell's remarks at the Jackson Hole symposium, solidifying market expectations for a rate cut by the central bank in the coming month.

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This rally led to a decline in yields, with rates falling by at least 4 basis points across various maturities. The yield on the 10-year Treasury note dropped by 5 basis points, settling at 3.8%, while the 2-year yield decreased from 4% on Thursday to approximately 3.94%.

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Tracy Chen, a portfolio manager at Brandywine Global Investment Management, characterized the market’s reaction as a "relief rally." She explained that Powell’s comments reinforced the belief that the Fed is on track to lower interest rates, despite his continued emphasis on being guided by incoming economic data. Chen noted, “The market still needs his confirmation," indicating that while Powell didn’t provide a specific timeline for the rate cuts, the shift in focus from inflation concerns to labor market issues has become more evident.

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Following Powell's speech, overnight index swaps revealed that traders are now heavily betting on a rate cut of at least a quarter percentage point at the Fed's September policy meeting. Additionally, there's a more than 20% probability priced in for a more significant 50 basis point reduction. In total, market participants are anticipating 100 basis points of rate cuts for the entire year.

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During the annual Jackson Hole symposium in Wyoming, Powell indicated that "the time has come for policy to adjust," signaling a potential shift in the Fed's approach. He highlighted that the direction of policy changes is now clear, but the timing and pace of rate cuts will remain dependent on incoming economic data, the broader economic outlook, and the balance of risks. Powell also acknowledged the ongoing slowdown in the labor market, describing it as “unmistakable.”

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The bond market has been rallying since May, driven by cooling inflation and signs of a softening labor market, which led investors to anticipate that the Fed would initiate a cycle of easing in September. A recent unexpected rise in the unemployment rate further heightened concerns that the Fed might be moving too slowly to reduce borrowing costs, which have reached their highest levels in more than two decades.

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While expectations for aggressive Fed rate cuts have moderated since then, current market pricing still suggests that a half-point cut could occur during one of the three remaining policy meetings this year.

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Ed Al-Hussainy, a rates strategist at Columbia Threadneedle Investments, pointed out that Powell’s focus on labor market conditions represents a critical turning point toward normalizing monetary policy. He argued that this shift is even more significant than the ongoing debate over whether the Fed will opt for a 25 or 50 basis point cut in September.

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Powell's speech at Jackson Hole has provided the market with a clearer sense of direction regarding the Fed's future policy moves. Although the timing and magnitude of the rate cuts remain uncertain, the emphasis on labor market dynamics suggests that the Fed is becoming increasingly concerned about economic growth and is preparing to adjust its policy accordingly. As the economic landscape continues to evolve, market participants will be closely monitoring incoming data to gauge the Fed's next steps.

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This ongoing adjustment in expectations has led to a rally in Treasuries, as investors recalibrate their views on future interest rates. The interplay between inflation, labor market conditions, and the Fed's response will continue to be a key focus for markets in the coming months.

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In conclusion, while the exact path of rate cuts remains uncertain, Powell's remarks have reinforced the belief that the Fed is poised to begin easing soon, with labor market concerns now taking center stage in the central bank's decision-making process. As a result, Treasury yields have fallen, reflecting the market’s anticipation of a shift in monetary policy.

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