Bond traders close for ‘No Land’ after jobs surprise

(Bloomberg) — The “no-land” scenario — a situation in which the U.S. economy continues to grow, inflation reignites and the Federal Reserve has little room to cut interest rates — has largely disappeared as a topic of discussion in the bond market in recent months.

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It only took a payroll exploitation report to revive it.

Data showing the fastest job growth in six months, a surprise drop in U.S. unemployment and higher wages sent Treasury yields higher and investors furiously reversing course on bets for a larger-than-normal interest rate cut of half a point as soon as next month. .

It’s the latest jolting recalibration for traders who have been bracing for slower growth, benign inflation and aggressive rate cuts by piling into short-term Fed rate-sensitive US bills. Instead, Friday’s report revived a new set of concerns about overheating, denting the rise in Treasuries that has pushed two-year yields to multi-year lows.

“The pain trade has always been higher rates on the upfront side because of smaller price cuts,” said George Catrambone, head of fixed income, DWS Americas. “What could happen is that the Fed either stops cutting interest rates or actually finds itself having to raise rates again.”

Much of the recent market debate has focused on whether the economy will be able to make the “soft landing” of the deceleration without a recession or head for the “hard landing” of a severe recession. The Fed itself has signaled a shift in focus toward preventing labor market damage after battling inflation for more than two years, and its pivot to cutting rates began with a half-point burst in September.

But Friday’s payrolls report provided ammunition for those who see a disconnect in Fed rate cuts when inventories are at a record high, the economy is expanding at a solid pace and inflation has yet to return 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, have warned that the Fed should not be bogged down by market projections for lower rates or its own projections, with El-Erian warning that “inflation is not dead” . Former Treasury Secretary Larry Summers said in a Friday X post that “no landing” and “hard landing” are risks the Fed must consider, saying last month’s huge tapering was “a mistake “.

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For some, the Fed’s huge tapering last month, combined with China’s surprising blitz of stimulus, is tipping the scales away from growth concerns.

“The 50 basis point cut should be ruled out now,” said Tracy Chen, portfolio manager at Brandywine Global Investment Management. “Fed easing and China’s stimulus raise the likelihood of a no-go landing”.

Meanwhile, inflation concerns are returning after crude oil rose. The 10-year yield, a measure of bond traders’ inflationary expectations, hit a two-month high, rebounding from a three-year low in mid-September. This is ahead of key consumer price data due next week.

Swap dealers are pricing in 24 basis points of easing for the Fed’s November meeting, meaning a quarter-point cut is no longer seen as guaranteed. A total of 150 basis points of easing is seen through October 2025, down from expectations of cuts of around 200 basis points at the end of September.

The Fed’s cut in expectations has thrown cold water on the bond-buying frenzy that helped the Treasury post five straight monthly gains, its best stretch since 2010. Ten-year Treasury yields have risen more than 30 basis points since the Fed’s meeting on last month, approaching 4% for the first time since August.

“The Fed highlighted the importance of the labor market in its dual mandate that prompted the jumbo tapering last month, and now we’re here with evidence that the labor market is in good shape,” said Baylor Lancaster-Samuel, chief investment officer at Amerant Investments Inc. “It’s definitely kind of in the category of ‘Be careful what you wish for.'”

The changing narrative has also upended a recently popular strategy to bet on aggressive Fed easing: so-called curve steepening. In such a strategy, traders betting on short-term notes would outperform longer-dated debt. In contrast, two-year yields rose 36 basis points last week, the most since June 2022. At 3.9%, two-year yields are just 6 basis points below 10-year notes, narrowing se from 22 basis points at the end of September.

What Bloomberg strategists say…

“Yields rose on Friday as residual longs were halted and as investors aggressively sought to lock in rates before they rose. With signs of inflation lurking, few worries about a collapsing labor market and economic momentum on a positive trajectory, a soft landing may be bypassed altogether in favor of no landing.”

— Alyce Andres, Strategist Markets Live rates/FX

With a renewed focus on inflation, next week’s consumer price report looms large. It is expected to show that the core consumer price index fell to 0.2 percent last month after rising 0.3 percent in September. Fed Governor Christopher Waller said inflation data he got shortly before the Sept. 18 policy meeting ultimately pushed him to back a half-point move.

Certainly, current market prices suggest that a soft landing scenario remains investors’ base case. At 2.2%, the 10-year yield floor is still broadly in line with the Fed’s 2% inflation target. The swaps market shows traders expect the Fed to end its easing cycle at around 2.9% in 2027, in line with the level generally considered neutral.

Jamie Patton, co-head of global rates at TCW, says the latest jobs reading isn’t enough to change the need for the Fed to hold firm on an easing path as the totality of the data, including the drop in the rate of abandonment and the rise in default . auto loan and credit card rates, point to a shrinking labor market and downside risks to the economy.

“One data point does not change our macro view that the labor market is generally weakening,” Patton said.

She said she took advantage of Friday’s selloff to buy more two- and five-year notes, adding to a more bullish position. “Rekindling inflation fears could prevent the Fed from tapering,” but that would increase the risk that the Fed would keep borrowing costs “too high for too long and eventually trigger a bigger downturn.”

What to watch

• Economic data:

  • October 7: Consumer credit; monthly budget statement

  • October 8: NFIB Small Business Optimism; trade balance

  • October 9: MBA mortgage applications; commercial wholesale and inventory

  • Oct. 10: Consumer Price Index; initial unemployment claims

  • Oct. 11: Producer Price Index; U. of Mich. Sentiment and Inflationary Expectations

• Fed calendar:

  • October 7: Fed Governor Michelle Bowman; Minneapolis Fed President Neel Kashkari: Atlanta Fed President Raphael Bostic; The president of the Fed in St. Louis, Alberto Musalem

  • October 8: Fed Governor Adriana Kugler; Boston Fed President Susan Collins; Fed Vice President Vice President Philip Jefferson; Bostic

  • 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; Bostic

  • October 10: Richmond Fed President Tom Barkin; Fed Governor Lisa Cook; New York Fed President John Williams

  • October 11: Goolsbee; Logan; Archer

• Auction calendar:

  • October 7: 13, 26-week bills;

  • October 8: 42-day CMB; three year notes

  • October 9: 17-week bills; 10 year notes

  • October 10: 4, 8 week bills; 30-year bonds

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