The retreat of the US dollar + the steep bull market in US Treasuries, the "narrative logic" of the financial market is undergoing a transformation! The "rate cut trade" has become the main line

According to the report released by Mitsubishi UFJ Financial Group (MUFG), the institution believes that the significant underperformance of the U.S. non-farm payrolls in July, along with a substantial downward revision of previous values, has led to a sudden increase in market bets on the Federal Reserve lowering interest rates within the year. Data cited by MUFG shows that the interest rate futures market has priced in approximately 64 basis points of easing for the remainder of 2025—indicating that rate cut expectations are converging towards a 75 basis point cut this year, with the probability of a rate cut in September raised to 90%. The current bets in the interest rate futures market suggest at least two rate cuts before the end of the year, with increasing speculation of consecutive 25 basis point cuts in September and October, plus an additional 25 basis point cut in December, totaling three cuts of 75 basis points by year-end.

The MUFG strategy team stated that while it is still necessary to pay attention to subsequent employment and inflation data, from the perspective of interest rate pricing, the performance of the U.S. dollar index, and Wall Street's renewed embrace of the "steepening bull market in U.S. Treasuries" strategy, "the Federal Reserve is about to reopen the rate cut cycle" is gradually replacing the narratives of "Goldilocks" and "TACO," becoming the core logic driving financial market equity, debt, and currency trading.

MUFG noted that last Friday's disappointing non-farm data, combined with several economic indicators showing signs of weakness in the U.S. economy without a significant rise in inflation, greatly boosted market bets on the Federal Reserve's rate cuts. This non-farm employment report can be seen as the last straw that broke the camel's back for the hawkish forces within the Federal Reserve, with the September rate cut evolving from an option to a near certainty.

Mary Daly, the president of the San Francisco Federal Reserve, who has traditionally held a hawkish stance, stated on Monday local time that given the increasing signs of weakness in the U.S. non-farm employment market and the absence of sustained inflation driven by tariff policies, the timing for the Federal Reserve to restart rate cuts is approaching, and it is more likely that the Federal Reserve will need to cut rates more than twice this year.

Regarding non-farm employment data, while the July employment figure was unexpectedly low at just 73,000, the employment data for May and June was also unexpectedly revised down, totaling a reduction of up to 258,000 jobs, with a downward revision of an unprecedented 90%. The ISM Manufacturing Index, crucial for predicting the U.S. economy, saw the employment component unexpectedly drop to 43.4, indicating weakening demand for labor. Meanwhile, as of July, tariffs have not led to rising inflation, with the ISM price component unexpectedly falling from the previous value of 69.7 to 64.8.

Rate cut expectations resurge, U.S. Treasury "bull market steepening" sweeps Wall Street

MUFG stated that the gold, stock, foreign exchange, and bond markets are also actively pricing in the Federal Reserve's rate cut expectations, with gold rebounding from around $3,270 to nearly $3,400 since the end of July due to rate cut expectations; the two traditional safe-haven sectors, healthcare and consumer staples, led the U.S. stock market during the sharp decline on Friday The US dollar index fell 0.8% last Friday, and the USD/JPY exchange rate plummeted 2.2% in a single day—indicating a depreciation of the dollar and an appreciation of the yen, marking the largest decline since April. The dollar also experienced significant declines against other major currencies on Friday.

The warming expectations for a Federal Reserve interest rate cut, driven by labor market data, triggered a widespread rise in US Treasury bonds across various maturities. The "bull steepening" strategy of the yield curve for US Treasuries almost turned around in a day—particularly strong performance was noted in short-term (2 years and below) US Treasuries. The yield on the most interest-sensitive 2-year US Treasury bond fell by more than 25 basis points in a single day, marking the largest decline since December 2023—since bond prices and yields move inversely, a drop in yield signifies a substantial rebound in prices.

Although the price increase of long-term US Treasuries (10 years and above) was not as pronounced as that of short-term bonds, it also exhibited a rare comprehensive recovery, prompting a collective return of bulls to the US Treasury market. This further widened the yield spread between short and long ends, bringing considerable returns to investors betting on the so-called "steepening of the yield curve" strategy.

The so-called "bull steepening" strategy in the US Treasury market refers to a significant decline in short-end yields (such as those for 2 years and below) due to the sustained warming of expectations for Federal Reserve interest rate cuts, while long-end yields (such as those for 10 to 30 years) experience limited declines but overall show a downward trend, leading to a rapid widening of the long-short yield spread. The entire yield curve becomes steeper under the backdrop of a "price increase/yield decrease" bull market for US Treasury prices.

Could political pressure push the Federal Reserve's monetary policy balance towards dovishness?

According to MUFG, the political dynamics in the US are also trending towards favoring the warming of interest rate cut expectations. Although the erosion of the Federal Reserve's independence may lead to a correction in the stock and bond markets, as market outlooks on US economic growth momentum turn pessimistic, the logic for Federal Reserve interest rate cuts is still expected to dominate market trading logic, thereby continuously boosting gold, short-term US Treasuries, and long-term underperforming value stocks and small-cap stocks that benefit from Federal Reserve rate cuts for some time.

The extremely weak July employment report released in early August provided evidence supporting the view that "a rate cut should occur in July," which included dissenting opinions publicly raised by Federal Reserve governors Waller and Bowman—both supporting a rate cut in July—as well as pressure from President Donald Trump. At the same time, Trump accused the head of the Bureau of Labor Statistics of politicizing the employment report and called for his dismissal, further shaking an already fragile market.

Kathy Bostjancic, Chief Economist at Nationwide, stated: "The cracks in the labor market have widened significantly, further intensifying the pressure for a Federal Reserve rate cut and supporting the views of dissenting Federal Reserve governors that the FOMC should cut rates in July."

MUFG noted that due to significant downward revisions of employment data, President Trump dismissed the head of the Labor Department's statistics bureau and intensified his criticism of Federal Reserve Chairman Powell, calling for his resignation and suggesting that the Federal Reserve Board reclaim control. This marks an escalation of pressure from the Trump administration on the Federal Reserve's monetary policy independence. Therefore, in the view of MUFG's strategy team, the Trump administration's dismissal of labor statistics officials and calls for Federal Reserve Chairman Powell's resignation will inevitably elevate dovish voices within the Federal Reserve, potentially responding to the increasingly heightened expectations for interest rate cuts in the market