US Treasury yields rebound before next week’s key jobs data

NEW YORK – Interest-rate-sensitive two-year US Treasury yields rebounded from a more than three-month low on Friday ahead of January’s highly anticipated jobs report next week that will offer the next clues on the strength of the labor market.

Two economic reports on Thursday pointed to a weakening jobs picture, with jobless claims rising more than economists had expected last week, while job openings fell to a more than five-year low in December.

That prompted a sharp drop in yields as traders increased bets that the Federal Reserve may cut rates more times this year than previously thought.

Next week’s payrolls report may be key to confirming or allaying these fears for the near term.

‘HYPER-FOCUSED’ ON LABOR MARKET

“The market is hyper-focused on anything to do with the labor market currently, just given the fact that that’s why the Fed has been cutting and most likely will be the reason that they cut again if it shows true signs of continued weakness,” said Scott Pike, senior portfolio manager at Income Research + Management in Boston.

“To really get the market to meaningfully change its view on the path forward for the Fed, most likely it’s going to need to come from a surprise in the nonfarm payrolls report,” Pike said.

January’s jobs report, due on Wednesday, was delayed from Friday due to the government’s four-day partial shutdown that ended on Tuesday. It is expected to show that employers added 70,000 jobs in January, according to the median estimate of economists polled by Reuters. The unemployment rate is expected to stay steady at 4.4%.

The two-year note yield, which typically moves in step with Federal Reserve interest rate expectations, was last up 1.5 basis points at 3.498%, after reaching 3.426%, the lowest since October 17.

The yield on benchmark US 10-year notes was flat at 4.21% and dropped to 4.156%, the lowest since January 15.

The yield curve between two-year and 10-year notes flattened to 71 basis points.

Fed funds futures traders are now pricing in 58 basis points of cuts by year’s end, up from around 50 basis points earlier this week, indicating that they see a growing chance of a third 25-basis-point cut this year.

A recovery in the stock market also helped push yields higher on Friday, after a stock selloff boosted demand for safe-haven US government debt on Thursday.

“The volatility that we’ve been seeing in the equity markets and risk markets very recently certainly contributed to the drop in Treasury yields,” Pike said.

Traders are also continuing to evaluate the likely monetary policies of former Fed Governor Kevin Warsh when he takes over as Fed chair after Jerome Powell’s term ends in May.

Warsh had a reputation as an inflation hawk in his earlier stint at the central bank, but now advocates for rates to be lowered.

He has also argued that large Fed holdings distort finances in the economy, and any efforts to reduce the size of the US central bank’s balance sheet would tighten financial conditions.

Bank of America analysts led by Mark Cabana view concerns over Warsh’s balance sheet policies as overdone.

“Warsh is unlikely to be as balance sheet hawkish as funding markets fear,” they said in a report. Warsh is likely to support ample Fed reserves and would find it difficult to shrink the Fed’s balance sheet size without bank liquidity regulation change, they said.

(Reporting by Karen Brettell, Editing by Nick Zieminski, Rod Nickel)