Traders Shred Bets on Big Fed Rate Cuts on Resilient Economy

(Bloomberg) -- Treasury yields surged after signs of a resilient US economy in the latest data releases prompted traders to lower their expectations of aggressive Federal Reserve interest-rate cuts this year.

The move in Treasuries was led by the policy-sensitive two-year yield, which rose 16 basis points to nearly 4.12% on Thursday after readings of US retail sales and weekly jobless claims came in better than anticipated. Treasury yields were trading near their session peaks after 3pm in New York.

Traders pared back bets for a super-sized September rate reduction, pricing in less than 30 basis points of easing next month. They now see a total of 92 basis points of cuts for the remainder of 2024, down from more than 100 prior to the data.

This week’s volatile swings in bond yields reflects a broad market debate on whether the Fed kicks off its anticipated easing cycle next month with a cut of a quarter point or a half point.

“The market is hanging on to every data point and trading them because we’re getting so close to September, when a couple months back there were questions about when could this [Fed policy] pivot actually take place,” said Lindsay Rosner, head of multi-sector fixed income at Goldman Sachs Asset Management. “It’s very crowded in the trade around September. You’ve seen this volatility because the distribution of opinions around what the Fed can do is wide.”

US retail sales accelerated in July by more than forecast, suggesting consumers are resilient in the face of higher prices and borrowing costs. Initial applications for US unemployment benefits, meantime, fell for a second week to the lowest level since early July.

The bond market was positioned for soft retail sales and the two-year yield had held below 4% amid inflation reports that showed easing price pressures.

Leading into the data releases, open interest, or the amount of risk held by futures traders, in the 10-year note futures had surpassed 5 million for the first time due to a recent build-up of long positions targeting a bigger bond market rally. The data signals some potential profit squeeze on bullish wagers adding momentum to the selloff as traders look to lock-in profit as odds of half-point Fed moves diminish.

A large block trade in December futures that was consistent with a seller, compounded front-end weakness in the aftermath of the retail and jobs results.

“The market was over priced and had seen such a big move lower in yields, said Tom di Galoma, head of fixed income trading at Curvature Securities. “The fast money has been selling since the data was released.”

As traders pushed the two-year yield toward 4.10%, it is back to levels from the start of August, and the selling pressure extended out the curve with the 10-year yield rising 11.5 basis points to 3.95%. A further back up in Treasury yields is expected to find buyers, with the Fed seen likely to begin cutting rates at their September 17-18 meeting.

“It’s the beginning of the cutting cycle,” Matthew Miskin, co-chief investment strategist at John Hancock Investment Management, told Bloomberg Television. “If you get another opportunity to embrace bonds as yields back up, we would take it. We want that for our investors as we set up for 2025.”

Fed Chair Jerome Powell will speak at the end of next week at the annual central bank symposium held in Jackson Hole, Wyoming. After that, traders are on hold until the next US labor report in early September.

“There’s still a lot of uncertainty about what the Fed does in September,” said di Galoma.

European bonds followed US Treasuries lower as money markets pared wagers on the extent of interest rate cuts from the European Central Bank and Bank of England. The yield on 10-year German notes rose seven basis points to 2.25%, while the rate on UK peers rose 10 basis points to 3.93%.

The unexpected strength in the US economy also boosted the dollar. The Bloomberg Dollar Spot Index rallied 0.4% before trimming some of that rise. The move pared a recent drop that saw the gauge close at its lowest mark since April earlier in the week.

--With assistance from Edward Bolingbroke, Carter Johnson and Alice Gledhill.

(Adds quote in fifth paragraph and updates market data throughout.)