Exploding Non-Farm Payrolls "Ignite" Fed Rate Hike Expectations! US Treasury Bonds Face a New Wave of Selling Pressure, with Two-Year Yield Seeing Largest Increase in 14 Months

Due to the unexpected growth in non-farm payrolls in the United States in May, US Treasury traders have fully priced in expectations that the Federal Reserve will raise interest rates by the end of this year, driving up yields across the $31 trillion US Treasury market. The two-year US Treasury yield, which is most sensitive to changes in Federal Reserve policy, rose by 13 basis points to 4.17%, marking the largest single-day increase since President Trump's large-scale tariff policy shocked the market in April last year. The benchmark 10-year US Treasury yield, known as the "anchor of global asset pricing," also rose by 8 basis points to 4.55%. Strong jobs data shake up US Treasury market, two-year US Treasury yield sees largest increase in 14 months Data released by the US Bureau of Labor Statistics on Friday showed a gain of 172,000 jobs in non-farm payrolls in May, surpassing all economist expectations. The April increase was also revised significantly upwards from 115,000 to 179,000, making it the strongest job growth in over two years for the US in the past three months; the unemployment rate remained at 4.3% for the third consecutive month. Robust employment coupled with high energy prices may further increase pressure on the Federal Reserve to consider raising rates to curb inflation. Interest rate swap markets indicate that traders expect a 25 basis point rate hike by the Federal Reserve before the December policy meeting, with a probability of a rate hike in October at around 60%. Interest rate swap curve already pricing in a 25 basis point rate hike by the Federal Reserve before December Edward Harrison, macro strategist at Markets Live, commented: "The overall and historical data in the May US non-farm payrolls report immediately pushed the 30-year Treasury yield back above 5%." "With mid-section real interest rates quickly catching up, the trend of further flattening in the yield curve is expected to continue." Tracy Chen, portfolio manager at Brandywine Global Investment Management, stated: "This jobs report shows that the US job market is recovering and that the Federal Reserve should focus on the inflation problem." She pointed out that as the inflation rate approaches the unemployment rate level, "the Federal Reserve may already be behind the curve." Rising energy prices since the end of February's Middle East tensions have pushed both actual inflation and inflation expectations higher, leading to a historic reversal in the market pricing of the Federal Reserve's policy path prior to the outbreak of Middle East tensions in February, overnight index swap markets indicated that traders generally expected the Federal Reserve to cut rates by around 50 basis points in 2026. However, the energy shock caused by the war completely shifted the interest rate outlook. There is a growing consensus in the US Treasury market that the Federal Reserve's next move will be to raise rates. The stronger-than-expected US labor market data further reinforce these hawkish expectations. The sell-off in the bond market and the repricing of bets on Federal Reserve policy reflect investors' increasing belief that under the leadership of the new Fed chair Kevin Walsh, the Federal Reserve will have to raise borrowing costs to rein in inflation, which has been persistently higher than target levels. Kevin Flanagan, head of investment strategy at WisdomTree, stated: "The entire narrative logic has changed for the US Treasury market and the Federal Reserve." Inflation data becomes the next key catalyst Following the release of May non-farm payrolls data, there has been a surge in buying of call options on 10-year Treasury notes expiring in July. This position bets that yields on these securities will fall to around 4.4% in the next three weeks, coinciding with the release of US inflation data and the Federal Reserve's monetary policy meeting. Jeffrey Rosenberg, senior portfolio manager at BlackRock, commented in an interview: "The question is whether the Federal Reserve will act before the market or if the market will continue to drive Federal Reserve policy?" "So far, clearly it's the latter." He added that this means that at the first meeting of the Federal Reserve after Walsh officially takes over as chair, policy makers are effectively in a position of "catching up with the market." The US Consumer Price Index (CPI) data for May, to be released next Wednesday, will be the next major focus for policy makers and investors alike. Interest rate swap markets linked to this data show that traders expect the year-on-year increase in US May CPI to reach around 4.3%. If realized, this would be the largest increase since April 2023, as energy prices remain high against the backdrop of a stalemate in the Middle East war. Flanagan believes that the Federal Reserve will need to take a more balanced policy stance at the June 16-17 meeting, abandoning its previous bias towards rate cuts. Several Federal Reserve officials have already indicated that they cannot support rate cuts as inflation indicators in the US continue to exceed the 2% target and the deviation continues to widen. In recent weeks, these officials have also become more open to the idea of further rate hikes. Last year, the Federal Reserve cut rates three times in a row and lowered the federal funds rate range to 3.5%-3.75% in December, against a backdrop of signs of weakness in the job market. However, with signs of stabilization in the job market in January of this year, the Federal Reserve suspended its rate-cutting actions. Economists at BNP Paribas said in a report released after the jobs data was published: "The three rate cuts last year were based on the policy pattern after the Long-Term Capital Management (LTCM) crisis in 1998. With the US economy showing resilience beyond expectations, the Federal Reserve is likely to repeat the policy script of 1999, through three consecutive rate hikes withdrawing previous easing measures." They expect the first rate hike to take place in December, but also noted: "The timing might come sooner, depending on the development of the Middle East war and the performance of the labor market." Most major Wall Street banks have now abandoned their forecasts for rate cuts in 2026. However, Citigroup, one of the most accurate forecasters of Federal Reserve policy last year, maintained a different view in a report released after the jobs data was published. They expect the Federal Reserve to cut rates three times this year, by 25 basis points each time, with the first rate cut starting in September. Andrew Hollenhorst, chief US economist at Citigroup, said in a report on Friday that the strong May employment report will undoubtedly prompt Federal Reserve officials to focus more on the upside risks to inflation at the June policy meeting, rather than the risks of a weakening job market. However, he expects the US labor market to gradually cool over the next three months, leading the market to reconsider rate cut expectations. Hollenhorst stated: "Signs of weakness in the labor market in the coming months will become more apparent, and the focus of the market will eventually shift back from the risks of rate hikes to the possibility of rate cuts."