Bond traders are increasingly wagering that the US economy is teetering on the brink of a significant downturn, prompting expectations that the Federal Reserve may need to implement aggressive monetary easing sooner than anticipated to avert a recession. Concerns about elevated inflation have rapidly diminished, giving way to speculation that economic growth will stall unless the Fed reduces interest rates from their highest levels in over two decades. Currently, traders see about a 60% chance of an emergency quarter-point rate cut within a week.
This sentiment has sparked one of the most substantial bond-market rallies since the banking crisis fears of March 2023. Last week, the policy-sensitive two-year Treasury yield dropped by half a percentage point to below 3.9%, a level it hasn’t seen in comparison to the Fed’s benchmark rate — now around 5.3% — since the global financial crisis or the aftermath of the dot-com crash.
The rally continued on Monday, with the 10-year yield reaching 3.7%. Expectations of more aggressive easing have spread to other regions, with German yields hitting a seven-month low amid views that the European Central Bank (ECB) will follow the Fed in delivering significant rate cuts.
“The market concern is that the Fed is lagging and that we are transitioning from a soft landing to a hard landing,” said Tracy Chen, portfolio manager at Brandywine Global Investment Management. “Treasuries are a good buy here because I believe the economy will continue to slow.”
Futures traders are pricing in the equivalent of five quarter-point rate cuts from the Fed through the end of the year, suggesting unusually large half-point moves over the last three meetings. Such large downward moves have not been seen since the pandemic or the credit crisis.
For the ECB, the market is favoring a half-point cut in September for the first time in the current cycle, with a total of 90 basis points of easing priced in for the rest of the year.
However, bond traders have repeatedly misjudged interest rate directions since the pandemic’s end, often overshooting and being caught off guard by unexpected economic resilience or inflation persistence. Last year, bond prices surged on the conviction that the Fed would start easing policy, only to lose those gains as the economy remained robust.
“The market is overshooting and getting ahead of itself like we saw late last year,” said Kevin Flanagan, head of fixed income strategy at WisdomTree. “You need validation from more data.”
Market sentiment has shifted sharply following a series of data indicating a softening job market and cooling economic segments. On Friday, the Labor Department reported only 114,000 jobs created in July, well below forecasts, and an unexpected rise in the unemployment rate.
After the Fed kept rates steady on Wednesday, this data has fueled concerns that the central bank has been too slow to react, similar to its delayed response in raising rates post-pandemic. This perception is reinforced by policy easing already underway in Canada and Europe.
Fears of an economic slowdown and Fed delays have contributed to a significant selloff in US stocks last week, with sentiment further impacted by Berkshire Hathaway Inc.’s reduction of its Apple Inc. stake by nearly 50% during a substantial second-quarter selling spree.
“There’s been an enormous move in the 2-year yield in the past 10 days or so. Pricing a so-called safe-haven asset is tough, and it’s much harder to price riskier assets like stocks,” said Steve Sosnick, chief strategist at Interactive Brokers LLC. “Warren Buffett’s decision to lighten his Apple position doesn’t help sentiment.”
Economists on Wall Street are increasingly forecasting a more aggressive pace of Fed easing, with Citigroup Inc. and JPMorgan Chase & Co. predicting half-percentage-point cuts at the September and November meetings. Goldman Sachs Group Inc. has also raised the probability of a US recession in the next year to 25% from 15%, while noting that there are reasons not to fear a slump, including overall economic stability and the Fed’s capacity for rapid rate cuts.
The Treasury rally has pushed the benchmark 10-year yield — a key baseline for borrowing costs — to around 3.7%, the lowest since December, supported by a stock market decline following weak earnings reports from companies like Intel Corp., which announced significant job cuts.
“Locking in yield is clearly a priority for bond investors as more evidence of job market deterioration means rate cuts are likely coming, potentially fast and furiously in the next several months,” said Edward Harrison, a strategist. “Friday’s jobs report has intensified worries that the Fed is making a policy mistake.”
Kathryn Kaminski, chief research strategist at AlphaSimplex Group, noted room for further bond gains due to the stock market downturn and investors rushing to buy bonds before yields fall further. “People wanting to lock in rates creates a lot of buying pressure and there’s also risk-off sentiment,” Kaminski said. “The 10-year yield could drop closer to 3% if we see these Fed rate cuts by year-end.”
