Non-farm payroll data hits hard: Bond market bets on a 90% chance of a rate cut in September, key signals for a shift in Federal Reserve policy await revelation

According to Zhitong Finance APP, bond traders will carefully analyze the May employment report to capture signs of weakness in the labor market in order to determine the timing of the Federal Reserve's interest rate cuts. On Thursday, the number of initial jobless claims in the U.S. unexpectedly surged to an eight-month high, briefly pushing U.S. Treasury yields down to their lowest level in nearly a month, leading traders to almost fully price in expectations for a rate cut in September (previously expected in October). Although traders still expect the Federal Reserve to keep rates unchanged later this month, a significant surprise in Friday's non-farm payroll data could prompt them to readjust their expectations.

Tim Duy, chief economist at SGH Macro Advisors, wrote: "If the Federal Reserve wants to cut rates this summer, it needs to see a significant deterioration in the labor market. The latest data shows that the labor market continues to soften moderately but has not collapsed. Tomorrow's May employment report could change this picture."

Federal Reserve officials have previously stated that they need to wait for more data to decide on rate cuts while weighing the high inflation against the risks of a potential economic slowdown. Officials noted that the impact of comprehensive policy adjustments (especially trade policy) on the economy may take months to become clear.

Interest rate swap data shows that traders believe there is about a 25% chance of the Federal Reserve cutting rates in July after maintaining rates (4.25%-4.5%) at the June 17-18 meeting, with the probability of a rate cut in September as high as 90%, and the market has fully priced in two cumulative 25 basis point cuts within the year. Amid the uncertainty of the Trump administration's tariff policies, this week's economic data paints a complex picture of the job market: May's private sector job growth slowed to its lowest in two years, while April's job openings unexpectedly increased.

The market expects that Friday's May non-farm payrolls will show an increase of 125,000, down from the previous value of 177,000; the unemployment rate is expected to remain unchanged at 4.2%.

Jack McIntyre, a portfolio manager at Brandywine Global Investment Management, holds a bullish stance on bonds, stating, "The economy is leaning towards moderate weakness, and if you short bonds and the data on Friday is weak, you could face risks. Strong data can still be interpreted as noise rather than viewing weak data as an anomaly."

The policy-sensitive two-year Treasury yield stabilized at 3.91%, up about 2 basis points for the week. The 10-year Treasury yield briefly fell to 4.31% on Thursday but rebounded to 4.39% due to a sell-off in European bonds, remaining stable at that level during the Asian session on Friday.

Bond traders have been betting that short-term bonds will outperform long-term bonds (i.e., a steepening yield curve), based on the logic that the Federal Reserve will eventually cut rates, lowering short-term yields, while Trump's tax cuts may worsen the fiscal deficit, raising long-term borrowing costs.

Kelsey Berro, fixed income portfolio manager at JP Morgan Asset Management, pointed out that further steepening of the yield curve relies on the rise of short-term bonds, which requires more signals of a slowdown in the labor market