The selling wave of US Treasury bonds intensifies, betting on a 50 basis point rate cut to prevent a collapse

US bond prices fell sharply on Monday, deepening a sell-off triggered by strong labor market data, leading traders to significantly reduce bets on a large rate cut by the Federal Reserve.

As investors abandoned bullish bets on US Treasuries, major yields were pushed above 4%, the highest level since August. Since August 1, the money market has not implied a cut of less than 50 basis points by the end of the year. Traders now see an 80% chance of a 25 basis point rate cut by the Fed in November.

"The discussion is turning to whether there will be any more rate cuts," said Jan Nevruzi, rate strategist at TD Securities. "From an economic perspective, the situation is not as bad as before, which is causing the market to reprice the Fed." TD continues to expect a 25 basis point rate cut in November.

The 10-year US Treasury yield rose by as much as 6 basis points to 4.03% on Monday, while the 2-year US Treasury yield rose by up to 10 basis points to 4.02%. Poor performance of shorter-term US bonds briefly led to a temporary inversion of the yield curve. Historically, the yield curve slopes upward, with longer-term bonds paying higher yields, a norm that was broken after the Fed raised rates significantly over the past two years.

The latest volatility reflects the bond market's expectation of a recovery scenario where the Fed achieves a "soft landing" - with the US economy continuing to grow, inflation picking up again, and little room for the Fed to cut rates. Last Friday's nonfarm payrolls report reignited concerns about overheating in the economy, ending a five-month rally in US bonds.

"We expect yields to rise further, but also anticipate a gradual adjustment," wrote George Cole and other strategists at Goldman Sachs in a memo. "The strength of the September employment report may accelerate this process, reigniting discussions about the extent of policy constraints and the magnitude of Fed rate cuts."

Data on open interest contracts tracking the futures market on Monday showed a significant decline in several contracts related to the Secured Overnight Financing Rate (SOFR), indicating long positions surrendering.

Meanwhile, in the options market, there is a significant amount of new hawkish hedging against only a 25 basis point rate cut this year.

On Monday, economists at Citigroup said in a report that they expect the Fed to cut rates by 25 basis points in November, abandoning forecasts of a 50 basis point cut along with other Wall Street banks.

"The hurdle for not cutting rates in November is high, as a month of labor market data has not convincingly reduced the downside risks that have been growing for several months, involving multiple datasets that led officials to cut rates by 50 basis points in September," wrote Veronica Clark and Andrew Hollenhorst "We believe that the labor market will once again show weakness in the coming months, with overall inflation trends continuing to slow down. Federal Reserve officials are expected to cut rates by another 50 basis points by December."

Traders are now eagerly awaiting a series of speeches from Federal Reserve policymakers to further understand the interest rate outlook. The market is also waiting for the release of U.S. inflation data later this week.

Dario Perkins, Managing Director of TS Lombard, said, "Inflation can reach tolerable levels without a recession, so the Federal Reserve is easing policy rather than waiting for a real economic slowdown. So far, everyone should realize that the Federal Reserve is proactively cutting rates."

Alyce Andres, U.S. Interest Rate Strategist at Bloomberg, said, "There is no longer a path for a 50 basis point rate cut at the November FOMC meeting. The bond market is still adjusting to the new pricing reality."