Weak employment data raises interest rate cut expectations as investors increase bullish bets on U.S. Treasuries ahead of the release of August CPI

According to the Zhitong Finance APP, ahead of the release of the U.S. August CPI data this week, investors have increased their bullish bets on U.S. Treasuries, as a series of recent economic data that fell short of expectations has opened the door for the Federal Reserve to cut interest rates in September and further ease monetary policy in the coming months. JP Morgan's U.S. Treasury client survey shows that long positions have risen by 2 percentage points, while short positions remain unchanged at the highest level since early February this year. Additionally, in the week ending September 2, asset management companies increased long positions in most U.S. Treasury futures, with the most optimism surrounding 10-year Treasury futures. As the 30-year Treasury yield continues to stay away from the critical 5% level, the recent skew of options on the long end of the Treasury curve has shifted in favor of call options, indicating that traders are paying a slight premium to hedge against a decline in long-end yields rather than an increase. The market's dovish stance is reflected in open interest (i.e., new risk positions held by traders). Following last Friday's weak employment report, approximately 70,000 new contracts were added to October federal funds futures, marking the largest single-day increase for that month in history. In SOFR options, which closely track the Fed's policy path, there have been some large positions betting on a significant 50 basis point cut at next week's meeting—although this move is considered unlikely. Bill Adams, Chief Economist at Comerica Bank, stated, "It is now almost certain that the Fed will cut rates at next week's meeting, and there will be further cuts in the coming months. The question is how much the cut will be." After a series of reports indicating that the U.S. economy is cooling, the 10-year Treasury yield has fallen from its July peak to about a five-month low. Last Friday's non-farm payroll data showed that the U.S. added only 22,000 non-farm jobs in August, with the unemployment rate rising to its highest level since 2021. On Tuesday, another report from the U.S. Bureau of Labor Statistics showed that the total number of non-farm jobs in the U.S. was revised down by 910,000 for the year ending in March, significantly exceeding the market's expected downward revision of 700,000 Wall Street has hurriedly adjusted its predictions for the interest rate cut trajectory. Many now expect the Federal Reserve to take more aggressive rate-cutting measures. For example, Barclays economists now anticipate that the Fed will cut rates by 25 basis points at each of its remaining three meetings this year, whereas previous forecasts suggested only two cuts would occur through the remainder of 2025. Although interest rate swaps currently fully price in the expectation of a 25 basis point cut next week, a series of weak data has emboldened some market participants to bet on a larger cut. Standard Chartered's Global Head of G10 FX Research, Steven Englander, stated in a report on Tuesday before the employment revision data was released: "We recognize this is a preemptive action. But we expect the preliminary revisions to employment data from April 2024 to March 2025 to support our judgment of a 50 basis point cut in September." However, not everyone believes the Fed will be so aggressive in September or in the coming months. Tuesday's Fed swap data indicated that the total expected rate cuts for the remaining three meetings this year are priced at about 67 basis points, still about 8 basis points short of three cuts of 25 basis points each. Jeff Given, Senior Portfolio Manager at Manulife Investment Management, pointed out: "A significant 50 basis point cut would scare the market because everyone would ask, 'Are we missing something that the Fed knows?'" He added that if the September employment data rebounds, "then the Fed might indicate that they can cut rates once every other meeting going forward."