Weak employment data boosts expectations of interest rate cuts, investors increase bullish bets on US Treasury bonds on the eve of the release of August CPI data.

Prior to the release of the August CPI data in the United States this week, investors have increased their bullish bets on US treasuries, as a series of weaker-than-expected economic data have opened the door for the Federal Reserve to cut interest rates in September and further ease monetary policy in the coming months. Morgan Stanley's survey of US bond clients shows that long positions have increased by 2 percentage points, while short positions remain unchanged, maintaining the highest level since early February of this year. Additionally, in the week ending September 2nd, asset management companies increased their long positions in most US treasury futures, with the 10-year US treasury futures being the most favored. As the 30-year US treasury yield continues to stay far from the key level of 5%, the recent skew in options on the long end of the US treasury curve has turned in favor of call options, indicating that traders are paying a small premium to hedge against a decline in long-term yields rather than an increase. The dovish stance of the market is reflected in open interest contracts (i.e. new risk positions held by traders). Following the weak job report released last Friday, around 70,000 contracts of the October federal funds futures were added, marking the largest single-day increase for that month. In the SOFR options closely monitoring the Fed's policy path, there have been some large positions betting on a significant 50 basis point rate cut at the next meeting - although such a move is seen as unlikely. Comerica Bank's chief economist, Bill Adams, said, "It is now almost certain that the Fed will cut rates at the meeting next week, and there will be further cuts in the coming months. The question is how much the rate cut will be." Following a series of reports indicating a cooling US economy, the 10-year US treasury yield has dropped from its July high to approximately a five-month low. Last Friday's non-farm payroll data showed an increase of only 22,000 jobs in August, with the unemployment rate rising to its highest level since 2021. On Tuesday, another report by the US Bureau of Labor Statistics showed a downward revision of 911,000 non-farm jobs in the US up to March, far exceeding the anticipated 700,000 downward revision by the market. Wall Street has hastily adjusted its forecasts for rate cut trajectories. Many now expect the Fed to take more aggressive rate cuts. For example, Barclays economists now expect the Fed to cut rates by 25 basis points at each of the remaining three meetings this year, compared to previous forecasts of only two rate cuts left by 2025. Although rate swaps are fully pricing in a 25 basis point rate cut next week, a series of weak data has given some market participants the courage to bet on a larger cut. Steven Englander, global head of G10 forex research at Standard Chartered Bank, stated in a report on Tuesday before the employment revision data was released, "We realize this is a preemptive move. But we expect the preliminary revisions of employment data from April 2024 to March 2025 to support our view of a 50 basis point rate cut in September." However, not everyone believes that the Fed will be as aggressive in September or in the coming months. Data from the Fed swap markets on Tuesday showed that the total priced-in rate cut for the remaining three meetings this year was approximately 67 basis points, still about 8 basis points away from three meetings of 25 basis point rate cuts. Jeff Given, senior portfolio manager at Manulife Investment Management, pointed out, "A significant 50 basis point rate cut would scare the market because everyone would ask, 'Did we miss something that the Fed knows?'" He added that if September employment data rebounds, "then the Fed may indicate that they can cut rates once at every other meeting in the future."