Driven by stronger-than-expected U.S. non-farm payroll growth in May, U.S. Treasury traders have fully priced in the Federal Reserve’s interest rate hike expectations for the remainder of the year, causing yields across the $31 trillion U.S. Treasury market to rise broadly. The two-year Treasury yield, which is most sensitive to policy changes, jumped as much as 13 basis points to 4.17%, marking its largest single-day increase since April of last year when the Trump administration’s tariff policies shocked the market.
The ten-year Treasury yield, known as the “global asset pricing anchor,” rose 8 basis points to 4.55%. Strong employment combined with high energy prices further intensifies pressure on the Federal Reserve to consider raising interest rates to curb inflation. Interest rate swap markets show that traders expect the Fed to raise rates by 25 basis points before its December meeting, with a probability of around 60% for an October rate hike.
Edward Harrison, macro strategist at Markets Live, stated that the aggregate data and upward revisions to historical data in the May non-farm payroll report immediately pushed the 30-year Treasury yield back above 5%. Tracy Chen, portfolio manager at Brandywine Global Investment Management, pointed out that the labor market is recovering, and the Fed should focus on inflation. As the inflation rate gradually approaches the unemployment rate, “the Fed may have already fallen behind the curve.” A consensus is now gradually forming in the U.S. Treasury market that the Fed’s next move will be a rate hike. Kevin Flanagan, head of investment strategy at WisdomTree, said, “For the U.S. Treasury market and the Fed, the entire narrative logic has changed.”
Following the release of the May non-farm payroll data, the U.S. Treasury options market saw a large number of purchases of call options on ten-year Treasuries expiring in July, betting that yields on this tenor will fall back to around 4.4% over the next three weeks — a period that happens to cover the release of U.S. inflation data and the Fed’s policy meeting. Jeffrey Rosenberg, senior portfolio manager at BlackRock, noted that the question is whether the Fed will act ahead of the market or whether the market will continue to push the Fed to adjust policy. “So far, it’s clearly the latter.” The U.S. May CPI data, to be released next Wednesday, has become the next major focus. Swap markets indicate traders expect May CPI to rise about 4.3% year-over-year, which, if realized, would mark the largest increase since April 2023.
Economists at BNP Paribas expect that the Fed is likely to replicate the policy script from 1999, reversing its previous easing measures through three consecutive rate hikes, with the first hike possibly occurring in December, though this may also depend on Middle East tensions and labor market performance. Currently, most major Wall Street banks have abandoned their forecasts for rate cuts in 2026. However, Citigroup (C) maintains a different view, anticipating that the market’s focus will ultimately shift back from the risk of rate hikes to the possibility of rate cuts.
