For the first time since the US Federal Reserve began raising interest rates almost 18 months ago, the labor market is showing enough cracks to embolden some of the world’s largest bond investors to bet that the tightening cycle is finally ending.
A spate of slowing employment metrics two weeks prior, crowned by Friday’s August payrolls report, has shifted market sentiment in favor of owning policy-sensitive two-year treasuries.
The prospect of the Fed wrapping up its most aggressive tightening campaign in decades also drew investors to another favorite end-of-cycle trade — a steepening yield curve. The wager is that as the focus shifts to the timing of a potential Fed pivot to easing, short-maturity notes might fare better than long-term bonds.
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A US government report on Friday last week showed that the unemployment rate jumped to 3.8 percent, a level not seen since February last year, with wage growth moderated. It was the third soft labor-market release last week, following weaker-than-expected job openings data and an ADP Research Institute report showing slowing job additions by US companies.
The jobs data leave “the bond market comfortable with the view that the Fed is on hold for now and maybe done for the cycle,” Pacific Investment Management Co portfolio manager Michael Cudzil said. “If they are done for the hiking cycle, it’s then about looking at the first cut that leads to steeper curves.”
Short-term US Treasuries outperformed on Friday last week, sending the yield curve steeper. Two-year yields dropped roughly 20 basis points last week to below 4.9 percent. Meanwhile, 30-year yields were little changed on the week at around 4.30 percent, after rising above five-year yields for the first time in weeks.
As wage growth cools, BlackRock Inc portfolio manager Jeff Rosenberg said the Fed has to lower borrowing costs to avoid the real rate — or inflation-adjusted policy rate — from tightening.
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