Treasury Yields Set Three-Week High As Data Clouds Rate-Cut Path

Treasuries fell as data showing the labor market was holding up pushed yields to three-week highs and led traders to modestly lower expectations for Federal Reserve interest-rate cuts in the coming months.

Short-maturity rates, which track expectations for Fed policy most closely, led the move after weekly jobless claims came in below estimates while separate figures showed stronger-than-forecast quarterly economic growth. The two-year yield climbed about 5 basis points and reached the highest since early September at 3.67%. That extended a climb from a multi-month low of 3.47% last week just before the Fed lowered rates by a quarter-point. 

Traders slightly backed away from pricing in a quarter-point cut in late October. But they’re still leaning strongly in that direction after monthly employment data was revised sharply lower two weeks ago, suggesting a deterioration in hiring that added pressure on the Fed to reduce rates. 

“This morning’s economic data is not very supportive of further rate cuts, however I still believe rate cuts are coming in October and December due to a weakening labor market,” said Tom di Galoma, managing director at Mischler Financial Group.

The bond market retained the bulk of its session losses after a $44 billion sale of seven-year Treasuries drew moderately weaker demand than expected ahead of the 1 p.m. New York time auction deadline. 

The 10-year note rose 3 basis points to 4.17%, while the 30-year climbed 1 basis point to around 4.76%. Longer-dated yields lagged the increase in other maturities and that resulted in a flatter Treasury curve. The rate gap from five to 30 years fell below 1 percentage point for the first time since Aug. 11. 

A flatter curve tends to result when the market doubts the Fed’s ability to deliver a series of rate cuts toward the anticipated cycle low. Until this week traders had seen that low as likely around 3%, but a market measure of the terminal rate for this cycle has climbed to 3.11%.

“This month’s dataset takes the odds of a recession scenario a touch lower and the odds of a recovery a touch higher,” said Ed Al-Hussainy, a portfolio manager at Columbia Threadneedle Investment. “The net effect is to reprice the terminal rate higher.” He sees scope for it to move toward 3.5%, which would flatten the curve.

What Bloomberg Strategists say...“Traders are backing further away from the prospect of two more interest-rate cuts from the Federal Reserve by year-end, as a more robust set of economic data on Thursday signaled the economy may not need much more in the way of easing.”—Kristine Aquino, managing editor, Markets LiveFor the full analysis, click here.

Meanwhile, swaps indicate traders are pricing in around 20 basis points of easing at the Oct. 28-29 Fed meeting, down from about 22 basis points seen late Wednesday. For the year, swaps now show less than a combined 38 basis points for the October and December meetings, from around 42 basis points on Wednesday. 

“Our view for neutral is 3%, so it’s fairly priced for the most part,” said Molly Brooks, a US rates strategist at TD Securities. The bank expects “two more cuts in 2025 and then quarterly cuts in 2026,” and Brooks said that view was “not too dissimilar” to what the market is pricing.

Before the data, Stephen Miran, the Fed’s newest policymaker, reiterated his view in a Bloomberg TV interview that the neutral rate — a level that neither restricts or stimulates the economy — was falling, and advocated aggressive rate cuts to bring down the funds rate by some 1.5 to 2 percentage points from its current band of 4% to 4.25%. 

Appointed by President Donald Trump, Miran’s rate projections at last week’s policy decision indicated his preference for 1.5 percentage points of rate cuts through the end of this year.

The Fed, Miran said in the interview, risks damage to the economy by not moving rapidly to lower rates.

Earlier speakers provided a contrast in views. Vice Chair for Supervision Michelle Bowman said inflation is close enough to the central bank’s target to justify more rate cuts because the job market is weakening. The Kansas Fed’s Jeff Schmid signaled the central bank may not need to ease again soon, citing the need to keep bringing down inflation. 

Treasury completed this week’s slate of coupon debt sales with the seven-year auction, which was awarded at 3.953% , around 0.6 basis points higher than the indicated yield going into the bidding deadline. 

Bidding metrics were solid with a 12% primary dealer award, compared with the 9.6% average over the past six sales. It follows decent demand for both the 2- and 5-year note sales this week.