Treasury yields plummet after signs of broadening weakness in economy

Friday’s raft of U.S. economic data produced a cascading drop in rates across the Treasury market, pushing the policy-sensitive 2-year and benchmark 10-year yields to their lowest levels of the new year.

The 2-year yield TMUBMUSD02Y, 4.232%, which moves in coordination with expectations around the path of Federal Reserve policy, plummeted 19.1 basis points to below 4.3% after December’s U.S. jobs report included signs of slowing wage growth. The 10-year rate TMUBMUSD10Y, 3.549% reacted about 90 minutes later, dropping below 3.6% after a barometer of U.S. business conditions at service-oriented companies sank last month. Those moves were then followed by the 30-year rate TMUBMUSD30Y, 3.663% falling to almost 3.7%.

Taken together, Friday’s data gave the financial market reasons to hope that disinflationary forces are on the horizon and the world’s largest economy is slowing by enough that the Fed can shift away from its focus on combating inflation through rate hikes. The 2-year yield scored its biggest one-day drop since Nov. 10 and fell to its lowest level since Dec. 21. Meanwhile, fed funds futures traders boosted their expectations for smaller-than-usual, 25-basis-point rate hikes in February and March — as well as for rate cuts toward the end of this year — though the market and policy makers have long been at odds over the appropriate direction of monetary policy.

“The payroll number was good for the front end” of the bond market — producing demand for shorter-term government debt that pushed down the 2-year yield — “because the wage number was pretty benign,” said Tom Graff, head of investments at Baltimore-based Facet Wealth, which oversees $1.5 billion.

“But the services report was a bigger deal,” Graff said via phone. “There had been a thesis out there that while goods spending was weakening, services spending was still strong — and this flies in the face of that. This is pretty strong evidence that companies on the services side of the economy see weakness and, if that’s true, points to broader weakness in the economy.”

The bond market, usually one of the first places in the financial market to size up the most likely outlooks for the economy and the trajectory of Fed moves, has been vacillating between two narratives. Only a day ago, traders were at least willing to reconsider the possibility that the Fed’s main policy target could get above 5% by March. Now, they see fresh reasons to doubt the Fed will be able to keep rates high, with Friday’s economic data only reinforcing the narrative that policy makers will be forced to pivot and cut rates toward the end of the year.

That’s the case despite more comments from Fed officials on Friday to the contrary. Federal Reserve Gov. Lisa Cook said, “Inflation remains far too high, despite some encouraging signs lately, and is therefore of great concern.” Her colleague Raphael Bostic told CNBC the central bank needs to stay the course and that December’s jobs report didn’t change his view on monetary policy.

Bonds rallied even with the robustness of December’s payrolls report, which showed the U.S. created 223,000 new jobs, because traders were more focused on the modest rise in hourly earnings last month and slowdown in wage increases over the past year, according to head trader John Farawell with Roosevelt & Cross, a bond underwriter in New York.  Hourly pay rose a modest 0.3% in December, while the increase in wages over the past year slowed to 4.6% from 4.8% — numbers which produced a rally in both bonds and equities, he said.

On Friday, Treasury yields finished the New York session down for the week, with the 30-year rate having its biggest weekly drop since the period that ended March 6, 2020. Meanwhile, all three major U.S. stock indexes SPX, -0.08%   DJIA, -0.34% ended sharply higher and booked weekly gains.

“In general, we’ve been in an environment where good news is bad news for markets, and bad news is good news,” said EY Parthenon Chief Economist Gregory Daco, based in New York.

“The markets’ reaction likely indicates the belief the Fed may need to be less hawkish than previously thought, and that we are in an environment in which wage pressures are easing and the Fed can step off the ledge of large incremental increases in the fed-funds rate even if policy makers will not back down on their hawkish rhetoric,” Daco said.

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