Last week's non-farm data may provide Federal Reserve officials with room to cut rates again this month unless this week's inflation report shows an unexpected acceleration.
Bond traders hope that the U.S. market can wrap up a tumultuous year smoothly, unless unexpected inflation spikes introduce new variables.
Last Friday, as the monthly employment report showed that the labor market is cooling sufficiently to allow the Federal Reserve to cut interest rates again at the conclusion of its December 18 meeting, U.S. Treasury bonds continued their recent rebound. Non-farm payroll data was seen as the last key labor market indicator for the market before this. This week, the U.S. will also release CPI and PPI data, with the market expecting these reports to show a slight increase in inflationary pressures.
Gang Hu, managing partner at Winshore Capital Partners, stated, "Unless CPI rises significantly unexpectedly, given that the Federal Reserve believes its policy remains restrictive, its baseline is to cut rates this month. So I think U.S. Treasury yields have peaked."
This widespread belief has freed investors from the bond market sell-off frenzy in November when Trump's victory heightened the risk that his tariff and tax cut plans could reignite inflation. However, since then, as the market expects the Federal Reserve to ease policy again at this month's meeting (the last meeting before Trump's inauguration), attempting to guide the economy to a soft landing, U.S. Treasury yields have receded.
The benchmark 10-year U.S. Treasury yield has fallen to about 4.15% since hitting a post-election high of 4.5% on November 15.
However, due to significant uncertainty about the outlook, the calm period may be relatively short-lived. Much of this stems from questions about policy changes under Trump's administration, as his tax cut plan is expected to inject stimulus into an already strong economy and could accelerate bond sales by increasing the deficit. His tariff plan is another uncertain factor—this could drive up import prices and weigh on global trade, depending on its form.
These issues may limit the upside in the bond market as traders and Federal Reserve policymakers take a wait-and-see approach. Swap pricing suggests that policymakers might pause rate cuts at the January meeting next year.
Tracy Chen, portfolio manager at Brandywine Global Investment Management, said, "The U.S. economy is very resilient. The Federal Reserve may be closer to pausing the rate-cutting cycle, and they will pause rate cuts at some point early next year to readjust to Trump's policies and the upcoming data."
The employment data released last Friday supports the view that the Federal Reserve's still restrictive policy is cooling the economy. While the number of hires in November rebounded from a slowdown in the previous month, the unemployment rate unexpectedly rose. The market expects this data could provide Federal Reserve officials with room to cut rates again this month unless this week's inflation report shows an unexpected acceleration.
The median forecast from foreign media surveys suggests that core CPI in November (considered the best indicator of underlying inflation pressure) will rise by 0.3% month-on-month, the same as the previous month's data. Hartford Funds fixed income strategist Amar Reganti stated:
"All signs indicate that the Federal Reserve will cut rates in December, but inflation remains a major issue, so there is slight tail risk in the CPI data. However, given that U.S. Treasury yields have already declined since November, it would be difficult to see them decrease further unless we really start to see a significant drop in inflation, particularly because the policy uncertainty from the executive branch and Congress is too high next year."