Treasury yields fell sharply after recent data highlighted a continued slowdown in the U.S. labor market, fueling Wall Street’s expectations for Federal Reserve rate cuts. The latest Job Openings and Labor Turnover Survey (JOLTS) revealed job openings hit their lowest level since 2021, missing estimates and signaling a cooling employment landscape. This prompted an immediate reaction in the bond market, with yields declining across the board, particularly in shorter maturities. The bond market now prices in over 100 basis points of policy easing by the end of the year, including the possibility of a significant cut. Notably, a key segment of the yield curve briefly shifted back to a positive slope, a signal that some interpret as the economy teetering on the brink of a downturn.
“The markets are still cautious, seeking confirmation that the economy isn’t slowing down too rapidly,” commented Chris Larkin from E*Trade, a division of Morgan Stanley. “This week has offered little reassurance on that front.”
With the Federal Reserve poised to begin cutting rates in the coming weeks, the major question on investors’ minds is the size of the initial reduction. All eyes are now on the upcoming monthly U.S. employment data, due Friday, which will likely provide the answer.
Investors remain vigilant following last month’s jobs report, which heightened fears of an economic slowdown. Fed Chair Jerome Powell has emphasized that the central bank is now more concerned with risks to the labor market than with inflation. A disappointing jobs report this Friday could reinforce the case for a larger-than-expected rate cut.
“Markets are viewing September as a toss-up between a 25 or 50 basis-point cut,” noted Neil Dutta of Renaissance Macro Research. “A smaller cut risks reigniting concerns that the Fed is behind the curve. It’s better to cut 50 basis points when you can, rather than when you have to.”
Treasury yields on 10-year notes dropped four basis points to 3.79%, while the U.S. dollar weakened. The S&P 500 showed mixed performance, and Nvidia Corp. rebounded after a challenging start to September. The Japanese yen rose 1%, while the Canadian dollar underperformed most other developed currencies after the Bank of Canada cut rates and signaled the potential for further easing.
“Any signs of labor-market weakness heavily influence rate expectations and Fed policy outlooks, given Powell’s focus on employment,” said Dennis DeBusschere of 22V Research. “This makes the upcoming payrolls report even more crucial.”
The August jobs report is expected to show an increase of about 165,000 jobs, according to a Bloomberg survey of economists. While this would be higher than July’s 114,000 gain, it would still mark a slowdown in average payroll growth over the last three months, the smallest since early 2021. Krishna Guha at Evercore commented that while the job openings data was soft, it doesn’t suggest a sharp deterioration in the labor market.
“The low level of layoffs and slight uptick in hiring indicate that the labor market isn’t collapsing,” said Guha. “The JOLTS data slightly lowers the bar for what Friday’s jobs report needs to show for the Fed to consider a 50 basis-point cut in September.”
According to Scott Rubner of Goldman Sachs, a weak payrolls report could trigger a stock market correction. Systematic funds, like Commodity Trading Advisers (CTAs), are now positioned with a downside skew, indicating potential vulnerability over the next month. “This is the last week for unemotional demand,” Rubner wrote.
Moreover, Bank of America reported that clients were net sellers of U.S. equities for the second consecutive week, marking the largest net sale of shares since late 2020. Uncertainty around the economic outlook led institutional, hedge fund, and retail clients to offload U.S. stocks, with net sales totaling $8 billion in the week ending August 30th.
In this environment, bond traders are preparing for increased volatility in U.S. markets, driven by signs of a weakening economy. A key measure of volatility in U.S. rate markets reached its highest level since July 2023. Meanwhile, European rate markets remained stable, with the European Central Bank expected to cut rates by a quarter point. Kristina Hooper of Invesco anticipates a modest 25 basis-point cut from the Fed, which she believes will mark the beginning of a significant easing cycle.
Citigroup strategists see the risk/reward balance as favorable for positioning for a selloff in U.S. rates through payer options, according to strategists Jabaz Mathai and Jason Williams. “We believe the market could see yields rise further, given that recent data doesn’t point to significant weakening in economic activity,” they noted.
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