Traders crushed expectations of a significant interest rate cut by the Federal Reserve this year!

After the latest data showed resilience in the U.S. economy, traders reduced their expectations for a significant rate cut by the Federal Reserve this year, causing U.S. bond yields to soar.

The main factors driving the rise in U.S. bond yields are better-than-expected U.S. retail sales and initial jobless claims data for the week, with the 2-year U.S. bond yield rising by 16 basis points, nearing 4.12%.

Traders have scaled back bets on a significant rate cut by the Federal Reserve in September, expecting the rate cut next month to be less than 30 basis points. They now expect the Fed to cut rates by a total of 92 basis points by the end of 2024, lower than the over 100 basis points before the data was released.

Overall, traders are betting that the Fed's rate cuts in 2024 will be less than 100 basis points.

The sharp fluctuations in U.S. bond yields this week reflect market debates on whether the Fed will begin its anticipated easing cycle next month, and the widespread discussion of whether the cut will be 25 basis points or 50 basis points.

Lindsay Rosner, head of fixed income at Goldman Sachs Asset Management, said, "The market is watching every data point and trading because we are getting closer to September, when a few months ago people were still discussing when the Fed's policy would shift. Trading in September is very crowded, and you can see this volatility because there are various opinions on what the Fed will do."

U.S. retail sales in July exceeded expectations, indicating that consumers remain resilient despite rising prices and borrowing costs. Meanwhile, initial jobless claims in the U.S. fell for the second consecutive week to the lowest level since early July.

The bond market had initially expected soft retail sales data, with the 2-year U.S. bond yield remaining below 4%, as previous inflation data showed some easing of price pressures.

Ahead of the data release, due to recent long positions, open interest in 10-year U.S. Treasury futures contracts exceeded 5 million for the first time. Data suggests that bullish bets may face some profit-taking pressure, leading to selling, as traders seek to lock in profits amid reduced chances of a 50-basis-point rate cut by the Fed.

Tom di Galoma, head of fixed income trading at Curvature Securities, said, "Market valuations are too high, and yields have seen a significant decline. There has been selling pressure since the data release."

As traders pushed the 2-year U.S. bond yield to 4.10%, the yield has returned to levels seen in early August, with selling pressure extending to other maturities of U.S. bonds. The 10-year U.S. bond yield rose by 11.5 basis points to 3.95%. However, if U.S. bond yields further rise, many are expected to buy in, as the Fed is likely to begin cutting rates at the September meeting. John Hancock Investment Management's Co-Chief Investment Strategist Matthew Miskin said, "This is the beginning of a rate-cutting cycle. When yields rise, we will seize this opportunity. We hope to prepare our investors for 2025."

Federal Reserve Chairman Powell will speak at the annual central bank symposium in Jackson Hole, Wyoming next week. Following that, the next key data point will be the U.S. non-farm payroll report released in early September.

di Galoma stated, "There is still a lot of uncertainty about what the Fed will do in September."

As money markets simultaneously reduce bets on the extent of rate cuts by the European Central Bank and the Bank of England, European bonds followed U.S. Treasuries lower. Germany's 10-year bond yield rose by 7 basis points to 2.25%, while the UK's 10-year bond yield rose by 10 basis points to 3.93%.

The unexpectedly strong U.S. economy also boosted the dollar. The Bloomberg Dollar Spot Index rose by 0.4%, reversing earlier declines that had pushed the index to its lowest level since April earlier this week