U.S. employment data triggers a surge in U.S. Treasury bonds, with a 90% probability of a rate cut in September. Is the Federal Reserve's wait-and-see strategy still applicable?

The employment report, which was far below expectations, reignited the market's bets that the Federal Reserve would cut interest rates as early as next month, driving short-term Treasury yields to their largest single-day drop in a year.

On August 1st, according to Wallstreetcn, the U.S. Department of Labor released the non-farm payroll data for July, showing an increase of only 73,000 jobs, far below the expected 104,000. The data for the previous two months was significantly revised down by 258,000, leading to a "sharp brake" in the U.S. labor market, causing the two-year Treasury yield to plummet by 25 basis points to 3.71%.

Following the employment data, Wallstreetcn mentioned that the U.S. ISM Manufacturing PMI for July was 48, marking the fastest contraction in nine months, and the Treasury yield further declined to 3.674%, recording the largest drop since August 2, 2024—also triggered by weak employment data.

(The two-year Treasury yield plummeted by 27.7 basis points to 3.674%, Source: Wallstreetcn)

Traders have fully priced in expectations for two rate cuts this year, with a nearly 90% probability of a rate cut at the September meeting.

(The probability of a 25 basis point rate cut in September is as high as 89.6%, Source: CME FedWatch)

Previously, President Trump had continuously pressured Federal Reserve Chairman Jerome Powell to cut rates despite rising inflation expectations due to tariffs. The data released on Friday seems to mark the arrival of a turning point.

Employment Growth Unexpectedly Slows Sharply

Friday's market movement was triggered by a weak U.S. labor report.

The report showed that the U.S. non-farm payroll increased by only 73,000 in July, far below economists' median estimate of 104,000.

More importantly, the data for the previous two months was significantly revised down by nearly 260,000, bringing the average number of new jobs added over the past three months down to 35,000—this is the lowest level since the pandemic began in 2020.

Although job growth has been slowing since April, Federal Reserve Chairman Powell stated on Wednesday that the low unemployment rate indicates that the labor market is in a "balanced state," as government crackdowns on immigration have reduced labor supply. After his speech, market expectations for rate cuts briefly collapsed.

Gregory Faranello, head of interest rate trading and strategy at AmeriVet Securities, stated:

We expect the Federal Reserve to start cutting interest rates in September. It is somewhat surprising that a sitting Fed chair hinted at a strong labor market the day before, only to receive such data a few days later.

Wall Street Raises Rate Cut Expectations

As signals of a cooling job market become increasingly clear, strategists from multiple institutions have quickly adjusted their expectations.

Strategists at CreditSights expect that the Federal Reserve will cut rates by 50 basis points in September and make two more cuts of 25 basis points before December. Previously, they had anticipated that rate cuts would not begin until 2026.

Strategists, including Winnie Cisar and Zachary Griffiths, wrote:

The risk that the Federal Reserve is falling behind the curve in the labor market has increased, especially considering the recently announced tariff measures.

They also believe that the path for the 10-year Treasury yield to drop to 3.5% will be “faster than previously expected.”

Rick Rieder, Chief Investment Officer of Global Fixed Income at BlackRock, stated that the Federal Reserve should start by cutting rates by 50 basis points next month. He believes that even a 100 basis point cut would still leave interest rates above the inflation trajectory, so this move “would not have any destructive impact on inflation.”

In September of last year, the Federal Reserve began its easing cycle with a 50 basis point cut following a series of weak labor market reports.

Michael Collins, a fixed income manager at PGIM, advised clients to “enter the market while U.S. Treasury yields are still high,” and expressed a preference for bonds maturing in two to ten years.

Despite the excited market sentiment, there are also views suggesting that a single employment report may not be enough to completely alter the Fed's established course. Bloomberg macro strategist Edward Harrison pointed out:

Before the next Federal Reserve meeting, we will see another employment report, as well as additional CPI and PCE reports. As the inflation impulse from tariffs is just beginning to show, the impact of Friday's report on the Federal Reserve may not be as significant as traders believe.