Treasury Yields Are Sinking Ahead of Friday's Jobs Report, Signaling Growing Jitters

Yields on U.S. government debt continued to decline on Thursday, reflecting the bond market's increasing concern about the economy's overall strength ahead of Friday’s nonfarm payrolls report for July.

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The 10-year Treasury yield dropped below 4% intraday for the first time since February 2. This followed weak July manufacturing data and a rise in weekly jobless claims to their highest level in nearly a year. Traders were also looking ahead to Friday’s nonfarm payrolls report, anticipating it will reveal ongoing softness in the labor market.

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In times of low and stable inflation, Treasury yields often reflect the bond market’s outlook on the economy, with higher rates indicating growing optimism. However, yields have been falling since late April due to a prolonged rally in government debt and a growing belief that the Federal Reserve needs to start cutting interest rates, which currently stand between 5.25% and 5.5%.

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Thursday's yield drop resulted from various economic factors, including weak manufacturing activity reported by the Institute for Supply Management and higher-than-expected initial jobless claims, according to Tom Graff, chief investment officer at Facet, a Baltimore-based firm managing about $2.5 billion in assets.

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Graff explained that the yield drop signifies "nervousness, not panic." The bond market suggests that "not only is inflation coming down, which was already priced in, but there might be some real economic weakness, and that’s a change in narrative," he said on Thursday. He added that it would require a significant economic slowdown for the 10-year yield to drop to 3.5%, though it remains possible.

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Economists surveyed by the Wall Street Journal anticipate that Friday’s nonfarm payrolls report will show 185,000 jobs created in July, down from 206,000 in June, with the unemployment rate expected to stay at 4.1%.

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Whether the 10-year Treasury yield will continue trading below 4% will "ultimately come down to Friday’s employment report," said Ian Lyngen, a strategist at BMO Capital Markets. "For the time being, we are unwilling to fade the price action currently underway."

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Thursday’s data-driven rally in Treasurys caused yields to drop across various maturities, from the 1-year T-bill to the 30-year bond. The policy-sensitive 2-year yield fell 13 basis points to about 4.2%, while the 30-year yield dropped 8 basis points to 4.29%. The 10-year yield fell 11 basis points to 3.99%, after reaching a session low of 3.96%.

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"Labor-market data has been on the soft side for a couple of months, so investors have to consider the possibility that this is the beginning of a trend," said Graff. "If you consider that possibility, then all of a sudden that opens the door to possibly five or seven more rate cuts becoming a reality next year," in addition to the rate cuts already anticipated by traders for 2024.

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Eric Sterner, chief investment officer at Apollon Wealth Management in Mount Pleasant, S.C., which manages around $7.5 billion in assets, stated that the economy is slowing, even though consumer spending and the labor market remain "healthy." Meanwhile, concerns about the fiscal deficit trajectory persist, which should limit further yield declines leading up to the November 5 presidential election, he said.

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