(Bloomberg) — The “no landing” scenario — a situation in which the U.S. economy continues to grow, inflation reignites and the Federal Reserve has little room to cut rates — had largely disappeared as a talking point in the bond market in recent months.
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All it took was an explosive payroll report to revive it.
Data showing the fastest job growth in six months, a surprise drop in US unemployment and higher wages sent Treasury yields soaring and investors furiously reversing their bets on a half-point rate cut that was larger than normal next month. .
It’s the latest major recalibration for traders who had been bracing for slowing growth, favorable inflation and aggressive rate cuts by piling into the Fed’s interest-sensitive short-term U.S. bonds. Instead, Friday’s report revived a whole new set of overheating concerns, disrupting the rally in Treasurys that had sent two-year yields to multi-year lows.
“The pain trade has always been higher interest rates because fewer rate cuts were priced in,” said George Catrambone, head of fixed income at DWS Americas. “What could happen is that the Fed either stops cutting rates or actually has to raise rates again.”
Much of the recent market debate has focused on whether the economy would be able to achieve a ‘soft landing’ of slowdown without recession, or could tip over into the ‘hard landing’ of a severe downturn. The Fed itself had signaled a shift in focus to preventing a deterioration in the labor market after more than two years of fighting inflation, and the shift toward rate cuts began with a half-point bang in September.
But Friday’s wages report provided ammunition for those who see a break in the Fed’s rate cuts while stocks are at record highs, the economy is growing at a solid pace and inflation has not yet returned to the Fed’s target. In short: a no-landing scenario.
A number of prominent investors and economists, including Stanley Druckenmiller and Mohamed El-Erian, warned that the Fed should not be boxed in by market projections for lower interest rates or its own, with El-Erian warning that “inflation is not dead.” Former Treasury Secretary Larry Summers said in a post on
For some, the Fed’s excessive spending cuts last month, combined with China’s surprise stimulus, are tipping the balance against growth concerns.
“A 50 basis point cut should now be out of the question,” said Tracy Chen, portfolio manager at Brandywine Global Investment Management. “The Fed’s easing and China’s stimulus measures increase the chance of a no-landing.”
Meanwhile, concerns about inflation are reviving after crude oil rose sharply. The 10-year breakeven yield, a gauge of bond traders’ inflation expectations, hit a two-month high and recovered from a three-year low in mid-September. That’s ahead of key consumer price data due next week.
Swap traders are pricing in a 24 basis point easing for the November Fed meeting, meaning a quarter-point cut is no longer considered guaranteed. A total of 150 basis points of easing is priced in through October 2025, down from expectations for a cut of around 200 basis points at the end of September.
The rollback of Fed expectations has cooled the bond-buying frenzy, allowing Treasuries to post five straight monthly gains, the best since 2010. Ten-year Treasury yields have risen more than 30 basis points since the Fed met last month. increased. approaching 4% for the first time since August.
“The Fed emphasized the importance of the labor market in its dual mandate, which prompted the jumbo cut last month, and now we’re here with evidence that the labor market is in good shape,” said Baylor Lancaster-Samuel, Chief Executive Officer Investment Officer at Amerant Investments Inc. “It definitely falls a bit into the category of ‘Be careful what you wish for.’”
The shifting narrative also upended a recent popular strategy for aggressive Fed easing: so-called curve steepening. Under such a strategy, traders bet that short-term bonds would outperform longer-term debt. Instead, the two-year yield rose 36 basis points last week, the highest level since June 2022. At 3.9%, the two-year yield is just 6 basis points below 10-year government bonds, compared to 22 basis points at the end of September.
What Bloomberg Strategists Say…
“Yields rose on Friday as remaining long positions stalled and investors aggressively tried to lock in rates before heading higher. With signs of inflation looming, few concerns about a labor market collapse and economic momentum on a positive trajectory, it is possible that a soft landing could be sidestepped altogether in favor of no landing.”
— Alyce Andres, Markets Live rates/FX strategist
With a renewed focus on inflation, next week’s consumer price report looms. The core consumer price index is expected to cool to 0.2% last month after rising 0.3% in September. Fed Governor Christopher Waller has said that inflation data he got shortly before the September 18 policy meeting ultimately prompted him to support a half-point move.
To be fair, current market prices indicate that a soft landing remains the base case for investors. At 2.2%, the ten-year breakeven is still broadly in line with the Fed’s 2% inflation target. The swap market shows that traders expect the Fed to end its easing cycle in 2027 at around 2.9%, consistent with the level widely considered neutral.
Jamie Patton, co-head of global interest rates at TCW, says the latest employment data isn’t enough to change the need for the Fed to remain firmly on the easing path because the set of data, including the declining shutdown rate and rising bankruptcies, interest rates on auto loans and credit cards point to a weakening labor market and downside risks to the economy.
“One data point does not change our macroeconomic view that the labor market is weakening overall,” Patton said.
She said she took advantage of Friday’s sell-off to buy more two- and five-year bonds, adding to a position that steepened the curve. “Renewed inflation fears could keep the Fed from cutting spending,” but that would increase the risk for the Fed to keep borrowing costs “too high for too long and ultimately trigger a bigger downturn.”
What to watch
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Economic data:
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October 7: Consumer credit; monthly budget overview
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October 8: NFIB optimism for small businesses; trade balance
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October 9: MBA Mortgage Applications; wholesale sales and supplies
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October 10: Consumer Price Index; first unemployment claims
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October 11: Producer Price Index; U. of Mich, sentiment and inflation expectations
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Fed Calendar:
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October 7: Fed Governor Michelle Bowman; Minneapolis Fed President Neel Kashkari: Atlanta Fed President Raphael Bostic; St. Louis Fed President Alberto Musalem
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October 8: Fed Governor Adriana Kugler; Boston Fed President Susan Collins; Fed Vice Chairman Philip Jefferson; Bosnian
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October 9: Minutes of the September FOMC meeting; Dallas Fed President Lorie Logan; Chicago Fed President Austan Goolsbee; San Francisco Fed President Mary Daly; Collins; Jefferson; Bosnian
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October 10: Tom Barkin, president of the Richmond Fed; Fed Governor Lisa Cook; New York Fed President John Williams
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October 11: Goolsbee; Logan; Bowman
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Auction calendar:
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October 7: 13 and 26 week bills;
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October 8: 42 days CMB; three-year notes
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October 9: 17-week bills; 10-year notes
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October 10: 4 and 8 week bills; Bonds with a term of 30 years
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