US Treasury traders have fully priced in a Federal Reserve interest rate hike by year-end, following a much stronger-than-expected May jobs report. This has driven yields higher across the vast $31 trillion US Treasury market. The yield on the policy-sensitive 2-year US Treasury note surged as much as 13 basis points to 4.17%, marking its largest single-day jump since last April. The benchmark 10-year Treasury yield, often called the world's benchmark asset price anchor, climbed as much as 8 basis points to 4.55%.
The robust employment figures have jolted the bond market, with the 2-year yield posting its biggest gain in 14 months. Data released Friday showed the US economy added 172,000 jobs in May, surpassing all economist forecasts. April's figure was also revised sharply higher. The unemployment rate held steady at 4.3% for a third consecutive month. Strong job growth, coupled with elevated energy prices, is likely to increase pressure on the Fed to consider raising rates to combat inflation.
Interest rate swap markets now indicate traders expect a 25-basis-point Fed rate hike by the December policy meeting, with the probability of a move in October seen around 60%. The swaps curve is fully pricing in a quarter-point hike by year-end.
Markets Live macro strategist Edward Harrison noted the strong headline jobs number and historical revisions immediately pushed the 30-year Treasury yield back above 5%. He added that the trend of a flattening yield curve is expected to persist as real rates in the middle of the curve catch up rapidly.
Brandywine Global Investment Management portfolio manager Tracy Chen stated the report shows the US labor market is recovering and the Fed's focus should be on inflation. She pointed out that with the inflation rate gradually approaching the unemployment rate, the Fed may already be behind the curve.
Since the conflict in the Middle East escalated in late February, rising energy prices have driven both actual inflation and inflation expectations higher. This has forced a historic reversal in market pricing for the Fed's policy path. Prior to the conflict, markets were pricing in roughly 50 basis points of rate cuts for 2026. The energy shock from the war has completely shifted that outlook. A consensus is forming in the Treasury market that the Fed's next move will be a hike, and the stronger-than-expected labor data has reinforced this hawkish expectation.
The bond market sell-off and repricing of Fed policy bets reflect growing investor conviction that the Fed, under new Chair Kevin Warsh, will have to raise borrowing costs to contain inflation that remains stubbornly above target.
WisdomTree head of investment strategy Kevin Flanagan remarked that the entire narrative has changed for both the Treasury market and the Federal Reserve.
Inflation Data Emerges as Next Key Catalyst
Following the jobs data, the US Treasury options market saw significant buying of call options on 10-year notes expiring in July. This position bets the yield will fall back to around 4.4% over the next three weeks, a period covering the release of US inflation data and the Fed's policy meeting.
BlackRock senior portfolio manager Jeffrey Rosenberg noted in an interview that the key question is whether the Fed will act before the market, or if the market will continue to force the Fed's hand. So far, it has clearly been the latter, he added, meaning policymakers are essentially playing catch-up with the market ahead of Warsh's first meeting as chair.
The US Consumer Price Index (CPI) data for May, due next Wednesday, has become the next major focal point for policymakers and investors. Swaps linked to the data indicate traders expect a year-on-year CPI increase of around 4.3%. If realized, this would be the largest gain since April 2023, driven by persistently high energy prices amid the stalemated Middle East conflict.
Flanagan believes the Fed will need to adopt a more balanced policy stance at its June meeting, moving away from its previous bias toward easing. Several Fed officials have recently stated they cannot support rate cuts while inflation metrics remain persistently above the 2% target. In recent weeks, these officials have also become more open to the possibility of further rate hikes.
Last year, the Fed cut rates three times, lowering the federal funds rate target range to 3.5%-3.75% by December amid signs of labor market softening. It paused its easing cycle when the job market showed signs of stabilizing in January.
Economists at BNP Paribas stated in a report following the jobs data that last year's three rate cuts followed a policy pattern similar to that after the 1998 LTCM crisis. With the US economy now demonstrating unexpected resilience again, the Fed is likely to follow the 1999 playbook by implementing three consecutive rate hikes to withdraw prior stimulus. They expect the first hike in December but noted the timing could be brought forward depending on developments in the Middle East and labor market performance.
Most major Wall Street banks have now abandoned their forecasts for rate cuts in 2026. However, Citigroup, one of the most accurate forecasters of Fed policy last year, maintained a different view in its post-data report. It still expects three 25-basis-point rate cuts this year, starting in September.
Citigroup's chief US economist, Andrew Hollenhorst, stated in a Friday report that the strong May jobs report will undoubtedly lead Fed officials to focus more on inflation upside risks rather than labor market weakness at the June meeting. However, he expects the US labor market to cool gradually over the next three months, leading markets to reprice rate cut expectations. Hollenhorst added that signs of labor market softness will become more apparent in the coming months, and market focus will eventually shift back from hike risks to the potential for cuts.
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