The US May non-farm payrolls report comprehensively exceeded market expectations, leading to a fundamental shift in interest rate market pricing—traders are now fully pricing in a Federal Reserve rate hike this year, with the potential start time moved forward to as early as October.
Data released by the Bureau of Labor Statistics on Friday showed that non-farm payrolls increased by 172,000 in May. Combined with upward revisions to the prior two months' data, the three-month cumulative job growth reached its strongest pace in over two years. Following the data release, US Treasuries faced a broad sell-off, with yields rising across the curve. The policy-sensitive 2-year Treasury yield jumped 9 basis points on the day to 4.15%, while the 10-year yield rose 6 basis points to 4.53%.
The interest rate market subsequently underwent significant repricing. According to Bloomberg data, traders are now fully pricing in the probability of a 25-basis-point Fed hike by December, and assign about a 60% chance to a hike in October. SOFR futures yields rose as much as 8 basis points intraday, with the market now pricing in a cumulative 41 basis points of tightening by the end of April next year. In contrast, just a week ago, traders expected the next rate hike to occur in March of next year.
Currently, the Fed's benchmark interest rate target range remains at 3.5% to 3.75%, unchanged since last December. The persistent strength of the labor market, coupled with ongoing inflation risks, is driving a rapid market reassessment of the Fed's policy path towards a tighter stance.
Treasuries Sell Off Broadly, Short-End Yields Lead Gains
Following the jobs report, the US Treasury market reacted swiftly, triggering a broad-based sell-off. The 2-year Treasury yield rose 9 basis points to 4.15% on the day, while the 10-year yield increased 6 basis points to 4.53%. The larger gains at the short end of the yield curve reflect a concentrated repricing of market expectations for near-term monetary policy tightening.
John Briggs, Head of US Rates Strategy at the North American division of Natixis, stated, "The current employment data shows a recent acceleration, providing the market with a second reason to consider rate hikes, especially in the context of the continued blockade of the Strait of Hormuz and persistent inflation risks."
Rate Hike Expectations Suddenly Pull Forward, Reshaping Market Pricing Path
Prior to this data release, the market's prevailing expectation for the Fed's next move was a 25-basis-point hike in March next year. This expectation was completely overturned within hours of the data's publication.
Traders are now pricing in approximately 24 basis points of tightening for the October Fed meeting, close to a full 25-basis-point hike. For the cumulative tightening expected by the end of April next year, the market has priced in 41 basis points, equivalent to about one and a half hikes. The sudden forward shift in rate hike expectations reflects the market's judgment that labor market resilience and inflation persistence are simultaneously strengthening.
The market repricing triggered by this employment data further reinforces a growing view: the artificial intelligence boom is pushing the neutral rate higher, which in effect makes current Fed policy more accommodative than previously anticipated.
If the neutral rate has indeed risen, it implies that the current level of interest rates is exerting less actual restraint on the economy than the Fed's estimates suggest, thereby narrowing the policy space and providing a more compelling rationale for further hikes. Against a backdrop of a labor market showing no significant cracks and an overall hot economy, this logic is gaining increasingly widespread acceptance in the market.
Comments