Three weeks of consecutive gains is just the beginning? U.S. Treasury bulls bet on rate cuts to boost, Thursday's non-farm payroll report may become a "catalyst"

According to Zhitong Finance APP, U.S. bond traders have been striving amid market turbulence and ultimately managed to make a profit by the end of the first half of the year. Now, after three consecutive weeks of gains, they are preparing for more earnings, with Thursday's employment report potentially serving as a driving factor for this trend.

The U.S. Treasury market ended its best single-month performance since February and recorded the largest increase in the first half of the year in five years. Despite facing severe challenges from various complex factors, including President Trump's erratic policies, tariff uncertainties, geopolitical conflicts, and downgrades by Moody's rating agency.

While trade negotiations remain a focal point, some other pressures have eased as the month draws to a close. Yields are close to their lowest point in two months, with the benchmark U.S. 10-year Treasury bond around 4.28%. Moreover, investors have largely ignored the impact of Trump's tax plan—set to be voted on in the Senate on Monday after intense debates over the weekend—shifting their focus to the Federal Reserve, which is expected to cut rates at least twice this year.

George Catrambone, head of fixed income for the Americas at Deutsche Bank, stated, "The market tends to believe that the Federal Reserve will lower interest rates, while there is also some concern about missing out on opportunities." He noted that this situation would arise as Federal Reserve officials eventually reopened the rate-cutting cycle after pausing in December last year. Catrambone has recently increased interest rate-related investments, including investments in 30-year U.S. Treasuries, partly due to auction results showing strong foreign demand for U.S. government bonds.

Earlier this month, some investors believed the probability of a rate cut in July was close to zero, but now they estimate the likelihood of a cut at one in five, while a September cut has almost become a certainty. Even though Federal Reserve officials, including Chairman Powell, still prefer to wait for clearer economic conditions before easing policy again, traders are prepared to take action if key indicators like employment decline significantly while inflation remains manageable.

There has been a significant increase in interest rate options trading indicating a potential decline in yields and that the Federal Reserve will accelerate its easing policy, while asset management companies tend to hold U.S. Treasuries with maturities around five years, as these bonds are expected to experience a larger rally before 2026.

John Madziyire, a portfolio manager at Vanguard, stated, "For the Federal Reserve to be more aggressive in lowering rates, the labor market needs to deteriorate. The key in July is the employment data, which is the only factor that can influence market trends." Madziyire noted that holding U.S. Treasuries with maturities of 5 to 10 years is "quite attractive, as there are signs that the economy is slowing, so the interest rate risk you are taking on is compensated accordingly."The employment report for June will be released on Thursday. Economists predict that the report will show a slowdown in the growth of the labor force to about 113,000 new jobs, compared to 139,000 new jobs last month. The unemployment rate is expected to rise slightly to 4.3%, although it remains within a controllable range, this would be the highest since 2021.

Such data may not force the Federal Reserve to take action, but it will further demonstrate that economic growth is slowing. If the reported data is even weaker, the situation would be entirely different.

Dan Carter, a portfolio manager at Fort Washington Investment Advisors, stated regarding next month's Federal Reserve policy meeting: "If the employment data is poor and the inflation data does not show clear signs of tariff impacts, then I think July could be relatively optimistic. But it could also be one of those inconclusive situations ultimately decided by the Chair, and they might postpone the meeting until September."

Brendan Fagan, a Bloomberg foreign exchange strategist, added: "Whether the Federal Reserve will implement interest rate cuts in July is still uncertain. However, given the stagnation in economic growth and the emerging cracks in the labor market, extending the duration of bond holdings seems increasingly reasonable."

Since last December, market expectations for Federal Reserve rate cuts this year have fluctuated. However, the median forecast of policymakers (unchanged from March and June) is that the rate range will drop to 3.75% to 4% by the end of the year, indicating two cuts of 25 basis points each.

After a recent rise, the market is currently aligned with the Federal Reserve's expectations. If the employment report exceeds expectations, volatility may occur. With the deadline for Trump's tariffs on July 9 approaching, trade issues have once again become a focal point, and the government has sent mixed signals regarding the timing and intensity of the tariffs.

Despite the rise in June, yields remain in a relatively range-bound state, and current trading levels are well above the lows seen in April. Given the macroeconomic uncertainties that may keep the Federal Reserve on the sidelines, this situation has kept yields at current levels. Bank of America stated in its semi-annual report that the 2-year yield will reach 3.75% this year and in 2026, which is not far from current levels, while the 10-year yield is projected to be 4.5%.

On June 13, JPMorgan's interest rate strategists maintained their forecast that the yield on 10-year U.S. Treasuries will reach 4.35% by the end of the year, which is higher than the current level. The bank expects the Federal Reserve to cut rates for the first time in December, followed by three consecutive cuts early next year.

Lagging Behind the Yield Curve?

However, investors remain vigilant about the possibility that the Federal Reserve may miss opportunities due to excessive hesitation, as they worry that the Fed may lag behind developments due to its reluctance to gain a clearer understanding of economic conditionsLast week, Powell himself stated to the U.S. Congress that the Federal Reserve could adopt an easing policy earlier, and if there is a significant decline in hard data regarding inflation or employment growth, the Federal Reserve will at least implement two rate cuts of 25 basis points as predicted. Moreover, the employment market is a lagging indicator, which bond traders have also noticed.

Matthew Hornbach, Global Head of Macro Strategy at Morgan Stanley, stated in an interview last week that the firm expects the yield on 10-year U.S. Treasury bonds to reach 4% by the end of this year and "approach 3%" by the end of 2026. Hornbach pointed out that while they do not foresee any easing policies this year, the Federal Reserve "will significantly cut rates next year," when the temporary inflation impact from tariffs will have passed, and the weakness in the labor market will become apparent.

The divergence among Federal Reserve officials—who believe there will be zero to three rate cuts this year, with a broader range of cuts expected in 2026—has increased the likelihood of policy missteps, said Jamie Patton, Co-Head of Global Rates at TCW Group. She prefers to buy 2-year and 5-year bonds, as these bonds will benefit the most if the Federal Reserve's rate cuts exceed expectations.

Patton added, "There are a dozen pilots in the cockpit, and they have differing views on the altitude for landing at the destination airport. If the flight destination is unclear, there could be turbulence upon landing."