Non-farm data is about to come: Bond market bets 90% probability of rate cut in September, key signal of Federal Reserve policy shift awaits revelation.

Bond traders will carefully analyze the May employment report to capture signs of weakness in the labor market in order to determine the timing of a rate cut by the Federal Reserve. On Thursday, the weekly initial jobless claims in the US unexpectedly jumped to an 8-month high, pushing US bond yields briefly down to near a one-month low. Traders almost fully priced in expectations of a rate cut in September (previously expected in October) based on this data. While traders still expect the Fed to hold rates steady later this month, a significant surprise in Friday's nonfarm payrolls report could prompt them to reassess their expectations. Tim Duy, Chief Economist at SGH Macro Advisors, wrote, "If the Fed wants to cut rates this summer, they need to see a significant deterioration in the labor market. The latest data shows the labor market continuing to soften modestly, but not collapsing. Tomorrow's May employment report could change this picture." Federal Reserve officials have previously stated that they need to wait for more data to decide on a rate cut, balancing high inflation with the risks of a potential economic slowdown. They have said that the impact of comprehensive policy adjustments (especially trade policy) on the economy may take months to become clear. Interest rate swap data shows that traders believe the Fed is likely to hold rates steady (4.25%-4.5%) at their June 17-18 meeting, with a 25% probability of a rate cut in July and a 90% probability of a rate cut in September. The market has fully priced in two 25 basis point rate cuts within the year. Amid the uncertainty of the Trump administration's tariff policy, this week's economic data paints a complex picture of the employment market: private sector job growth in May slowed to its weakest pace in two years, while job vacancies unexpectedly rose in April. Market expectations are for a 125,000 increase in nonfarm payrolls for May, lower than the previous 177,000; the unemployment rate is expected to remain unchanged at 4.2%. Jack McIntyre, Portfolio Manager at Brandywine Global Investment Management, has a bullish outlook on bonds, stating, "The economy is tilting toward modest softness, so being short bonds could be risky if Friday's data is weak. Strong data can be explained away as noise, while weak data is harder to dismiss as abnormal." The policy-sensitive 2-year Treasury yield has held steady at 3.91%, with a cumulative increase of about 2 basis points this week. The 10-year Treasury yield briefly dropped to 4.31% on Thursday, but a sell-off in European bonds pushed it back up to 4.39%, where it remained stable in Asian trading on Friday. Bond traders have been betting that short-term bonds will outperform long-term bonds (i.e., steepening the yield curve). Their logic is that the Fed will eventually bring down short-term yields with rate cuts, while Trump's tax cuts could worsen the fiscal deficit, raising long-term borrowing costs. Kelsey Berro, Fixed-Income Portfolio Manager at J.P. Morgan Asset Management, noted that further steepening of the yield curve depends on a rise in short-term bonds, which would require more signals of a slowdown in the labor market.