Bond market expected to explode! Traders fully price in three rate cuts this year

After Federal Reserve Chairman Powell directly put the possibility of a rate cut in September on the table, unexpectedly weak U.S. economic data has strengthened the bond market's explosive expectations for a rate cut by the Fed.

On Thursday, August 1st, Eastern Time, pricing of swap contracts showed that traders had fully digested the loose expectations of a total 75 basis points rate cut by the Fed this year. This means that they expect the Fed to cut rates by 25 basis points at each of the remaining three monetary policy meetings this year.

The Federal Reserve's monetary policy meeting that ended on Wednesday announced a decision to keep interest rates unchanged, but made a significant shift in the policy statement, no longer referring to "remaining highly vigilant about inflation risks," but instead focusing on the risks facing the dual mandate of employment and inflation, seen as paving the way for future rate cuts. Following the meeting, Federal Reserve Chairman Powell stated in a press conference that a rate cut in September could be an option, if the overall data and evolution of risk balance give the Fed more confidence in declining inflation and the labor market remains strong, the earliest possible rate cut could be in September. The general view of the Federal Open Market Committee (FOMC) is that the time for a rate cut is approaching, but it has not yet fully reached that point.

Subsequently, the number of initial jobless claims in the U.S. last week unexpectedly rose to 249,000, hitting a one-year high, indicating signs of cooling in the labor market. Also released on the same day, the U.S. ISM Manufacturing Index for July did not rebound as expected by economists, instead falling to 46.8, the lowest since November last year, indicating the largest contraction in manufacturing activity in eight months, further highlighting weakness.

After the data was released, investors increased their bets on a rate cut by the Fed this year. U.S. Treasury prices continued to rise after posting their largest monthly gain in July, pushing yields further down. Following the release of the ISM data in early trading, the yield on the benchmark 10-year U.S. Treasury note fell below 4.0% for the first time since February, while the more rate-sensitive 2-year U.S. Treasury yield dropped below 4.20%, also hitting a new low in about six months.

Gregory Faranello, head of U.S. rate trading and strategy at AmeriVet Securities, commented that the expectation of three rate cuts does feel a bit excessive, but after Powell's speech laid the foundation, there is a big gap between now and the next Fed meeting on September 18th, and any weak data during this period will exacerbate the current price trend. He expects that the number of people betting on a 50 basis points rate cut in September may increase Ian Lyngen, the head of US interest rate strategy at BMO Capital Markets, stated that market pricing reflects investors' increasing concerns that the Federal Reserve may need to act at a faster pace than a 25 basis point rate cut per quarter as the economic downturn worsens. The likelihood of a 50 basis point rate cut in September is considered small unless there is a decrease in employment numbers or a decline in core CPI.

Furthermore, some analysts have commented that ahead of the release of the highly anticipated July non-farm payroll report this Friday, the US Treasury market has seen bullish positions crowded due to investors' expectations of a significant easing cycle. Therefore, if the employment report data is strong, investors may reduce their bullish bets, potentially triggering a rise in interest rates