On Monday, prices of various maturities of US Treasuries across the board plunged, exacerbating the collapse in Treasury trading triggered by strong labor market data, causing a sharp upward shift in the US Treasury yield curve (US Treasury yield changes inversely with price changes). The latest incredibly strong US non-farm payroll data, as well as an unexpected drop in the unemployment rate, led to a significant reduction in traders' bets on the Federal Reserve continuing to cut rates by 50 basis points.

As most bond traders globally at least temporarily abandon bets on US Treasuries going up, pushing the 10-year US Treasury yield, known as the 'global asset pricing anchor', to its highest level since August, breaking through the key US Treasury yield threshold of 4%. Since August 1st, the interest rates futures market pricing for the first time suggested that the Federal Reserve's benchmark interest rate cut by the end of the year would be less than 50 basis points, indicating that some traders are even pricing in the possibility that the Fed may choose not to cut rates at the FOMC meetings in November or December.

From a theoretical perspective, the 10-year US Treasury yield is equivalent to the risk-free rate indicator r at the denominator end of the important valuation model in the stock market – the DCF valuation model. When other indicators (especially cash flow expectations at the numerator end) have not significantly changed, or even in a scenario where there may be downward expectations in the October US stock earnings season, a higher denominator level or one that continues to operate at historically high levels, would lead to the valuation of risky assets such as US technology stocks, high-risk corporate bonds, cryptos, etc., being likely to contract as valuations are at historically high levels.

Traders now believe that there is an 85% likelihood that the Fed will switch to a 25 basis point rate cut in November. In contrast, when the non-farm payroll report was released, the probability of a 25 basis point rate cut bet in the bond market barely exceeded 50%, while the probability of betting on a 50 basis point rate cut at one point exceeded 25 basis points.

Ray Naeem, a rate strategist at TD Securities, said: 'The market's focus of discussion is even shifting to whether rate cuts will continue.' From an economic perspective, the situation is not that bad, leading to a repricing of the Fed's rate cut path in the market.' TD Bank continues to expect that the Fed will choose a 25 basis point rate cut in November, rather than persisting with a 50 basis point rate cut.

Traders are pulling back on their bets on the Fed's substantial interest rate hike path - a sharp rebound in non-farm employment data is forcing traders to readjust their bets on interest rate cuts.

The yield on 10-year US Treasuries rose by 6 basis points as of Monday trading hours, to 4.03%, while the yield on 2-year US Treasuries, more sensitive to interest rate expectations, rose by 10 basis points, to 4.02%. Short-term US Treasuries of 2 years and below performed poorly, marking a temporary inversion of a key part of the US bond yield curve, highlighting a significant cooling of the bond market's expectations for the Fed's future interest rate cuts. Historically, the US bond yield curve usually slopes upwards, with higher yields on longer-term bonds. However, this norm has been interrupted in the last two years due to the Fed's initiation of an aggressive interest rate cutting cycle.

These latest betting measures can be said to reflect the bond market's expectation for the Fed to lead a scenario of "no landing" for the US economy - that is, continued growth in US employment and the entire economy, resurfacing inflation rates, and the Fed having almost no room for interest rate cuts. Friday's incredibly strong non-farm employment report has once again raised concerns about the overheating of the US economy, disrupting the five-month upward trend in US Treasury yields.

According to data released by the US government on Friday, following upward revisions of 0.072 million non-farm employment in the previous two months, non-farm employment in September surged unexpectedly by 0.254 million, marking the largest increase in non-farm additions in six months. In contrast, economists' median expectation was only 0.15 million, with the latest non-farm figures exceeding even the most optimistic expectations shown in media surveys. According to another data released by the US Bureau of Labor Statistics on Friday, the unemployment rate unexpectedly fell to 4.1%, hourly earnings rose by 0.4% more than expected, both data points surpassing economists' expectations (4.2% for the unemployment rate and 0.3% for hourly wage growth).

Combined with other data released last week, US companies' demand for workers remains healthy, with very low layoff numbers. Earlier economic data also indicates the resilience of the US economy, and the non-farm employment report is likely to significantly alleviate economists' concerns about a rapid cooling of the US labor market and fears of an economic recession. The situation in the US labor market is closely related to US consumer spending, with employment scale and wage income being crucial for overall consumption. Consumer spending resilience will undoubtedly drive the US economic juggernaut forward, as 70%-80% of components in the US GDP are closely related to consumption.

"We had expected a stronger yield curve, but also anticipated a gradual adjustment process," wrote strategists from Goldman Sachs, including George Cole, in a report. "The strength of the September non-farm employment report may accelerate this process, reigniting debates on the extent of monetary policy restrictions, which in turn could deepen the impact on the US economy further and increase the Fed's interest rate cut extent."

Monday's open interest statistics (tracking positions in the futures market) saw a significant drop in several contracts related to the overnight Secured Overnight Financing Rate (SOFR), indicating that the US bond bulls are surrendering. Meanwhile, in the more popular options market, there are new "Fed hawkish hedge" trades emerging, betting that the Fed will only cut interest rates by 25 basis points this year - meaning there could be a choice to not cut rates during the next two meetings.

It is understood that economists from Citigroup, a major Wall Street bank, stated in a report on Monday that they expect the Federal Reserve to cut interest rates by 25 basis points in November, rather than the previously expected 50 basis points. Following the release of September non-farm payroll data on Friday, which suggested that the US economy remains strong, Citigroup joined other Wall Street banks in abandoning the aggressive forecast of a 50 basis point rate cut.

Citigroup economists Veronica Clark and Andrew Hollenhurst wrote in this report, "The threshold for the Fed not cutting rates in November is quite high, as one month of labor market data has not convincingly reduced the downside risks to the economy, which have persisted for several months, and many data sets drove Fed officials to choose a 50 basis point rate cut in September." "We believe that weakness in the labor market will reappear in the coming months, overall inflation trends will continue to slow, which may lead Fed officials to choose a 50 basis point rate cut in December."

Traders are now eagerly awaiting a series of speeches by several Federal Reserve officials scheduled for this week to further understand the dynamics of interest rate trends. They are also awaiting the release of US inflation data later this week. Economists generally expect the US Consumer Price Index (CPI) for September to rise by 0.1%, potentially marking the smallest increase in three months. Federal Reserve Chairman Jerome Powell recently emphasized that the Fed officials' interest rate dot plot forecasts, combined with their September policy rate decision, indicate that the Fed will choose to cut rates by 25 basis points at the final two FOMC meetings this year, totaling a 50 basis point rate cut.

Dario Perkins, Managing Director at TS Lombard, said, "The Federal Reserve does not need an economic recession to achieve an acceptable level of inflation, so the Fed has relaxed its monetary policy without waiting for a real economic slowdown." "Everyone should realize by now that the Fed is proactively choosing preemptive rate cuts and will not stop immediately."

"In our view, the possibility of a 50 basis point rate cut being chosen at the November FOMC meeting no longer exists. The US bond trading market is still adapting to the new pricing reality." Bloomberg strategists' economist team stated.

In September, the Federal Reserve began its first rate-cutting cycle in four years, cutting rates by a higher than expected 50 basis points. Federal Reserve Chairman Jerome Powell stated that this move aims to protect the resilience of the US economy, with the purpose of "preventative" rate hikes rather than recession-driven motives. Recently, Powell has repeatedly emphasized that Fed officials are not seeking or welcoming further cooling of the labor market conditions. Powell and other Fed officials have hinted in various wordings that the Fed's future work is to avoid an economic downturn and ensure a "soft landing" for the US economy.

Editor/rice