Treasuries Dip as Data Support Gradual Pace of Fed Rate Cuts

(Bloomberg) -- Treasury yields ticked higher Friday after the Federal Reserve’s favored inflation gauge reinforced the outlook for a less-aggressive pace of interest-rate cuts starting next month.

The move was led by short-term yields — more sensitive than longer-term ones to Fed rate changes. For US two-year notes, yields climbed as much as 3.7 basis points to 3.92% after the inflation gauges embedded in July personal income and spending data rose in line with economist estimates. Treasury yields across maturities subsequently retreated from session highs to little-changed levels.

The brief creep higher in yields left intact the steep gains the world’s biggest bond market has accumulated in August as Fed policymakers indicated a September rate cut is likely. Swap contracts fully price in a quarter-point move and about 25% odds of the half-point cut forecast by at least two large US banks. Ahead of the US holiday weekend, focus had already started to turn to next week’s pivotal August labor-market data and an expected slew of new corporate bond offerings.

“The data was not better-than-expected, so the path of least resistance for yields was to test going a bit higher,” said Padhraic Garvey, head of global debt and rates strategy at ING Financial Markets. “Now we are in a watching-and-waiting period” for employment data “that won’t be enough to push the Fed into a fifty-basis-points cut.”

Interest-rate swaps continue to almost fully price in a half-point rate cut at some point this year, anticipating cumulative easing of close to 100 basis points over the Fed’s three remaining policy meetings.

“Consumer spending continues to surprisingly exceed all expectations, a clear indication that the economy continues to be in good shape with solid above-trend growth,” said Olu Sonola, head of US economic research at Fitch Ratings. “A 25-basis-point interest-rate cut is pretty much set in stone in September, but the Fed will still hope the jobs report next week does nothing to pile on the pressure for a 50-basis-point cut.”

At the annual Jackson Hole symposium last week, Fed Chair Jerome Powell said “the time has come for policy to adjust,” marking a turning point in the central bank’s battle against inflation. The Fed has maintained a target range of 5.25% to 5.5% for the benchmark rate since July 2023.

While trading volume was below average ahead of the US holiday weekend, Friday’s flows probably included ones tied to corporate bond offerings anticipated for next week. September is historically a heavy month for new corporate bond sales, concentrated in the several days after Labor Day. Also, Friday’s month-end bond index changes have the potential to drive activity, particularly around 4 p.m. New York time when the changes take effect.

US government debt is set for a fourth-straight month of gains, the best streak in three years. Through Aug. 29 it gained 1.54% for a 2.87% year-to-date return as measured by the Bloomberg US Treasury Total Return Index. 

The 10-year note’s yield slipped to a 14-month low of 3.67% in early August following weaker-than-expected July employment data and was set to end the month around 3.88%. 

Employers are estimated to have added 163,000 people to payrolls in August after 114,000 in July, according the median forecast in a Bloomberg survey of economists. The unemployment rate is seeing edging down to 4.2%.

Gennadiy Goldberg, head of US interest rates strategy at TD Securities, said on Bloomberg Television the bank expects the payroll change to exceed 200,000, in which case yields have scope to rise further. 

“The direction of travel is weakening,” Goldberg said, but “you’ve seen rates really rally quite dramatically over the course of the last month or so, and I think we’ve gotten a little bit ahead of ourselves.” Still, he expects a quarter-point rate cut in September and the 10-year yield to end the year at 3.4%.

--With assistance from Kristine Aquino and Ye Xie.

(Adds comments and context and updates yield levels.)

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