Data storm is coming! The bond market debates the script of the Fed's rate cut in 2026.

The debate in the US bond market is intensifying around the future rate cut by the Fed, as it enters a heated phase with a series of key economic data about to be released. This week's data will largely fill the information gap left by the US government shutdown, with previously delayed monthly employment and inflation data set to be released, and more key employment data to come in early January. These reports will help answer the core question facing the market in 2026: Is the Fed's easing cycle nearing its end after three consecutive rate cuts, or does it need to take more aggressive action? This is crucial for bond traders. Despite inflation remaining high, traders are betting that the Fed will cut rates twice next year to support the job market and economic growth prospects. This expectation is one rate cut more than what the Fed is currently implying - if the market is correct in its judgment, it will pave the way for a new robust rally in US bonds, making this year the best performing year for US bonds since 2020. "For next year's trend, the most important single data point may be the employment data released on Tuesday," said George Catrambone, head of fixed income at DWS Americas. "This is the only indicator I am watching, and the direction of the labor market will determine the direction of interest rates." Catrambone belongs to the camp expecting a significant rate cut by the Fed - judging from the soft labor indicators before the data release this week, the rate cut may be quite substantial. When yields on government bonds soared to multi-month highs last week, he had already increased his holdings in government bonds. At the beginning of this week, the yield on the two-year government bond, sensitive to policy changes, was around 3.5%, while the yield on the ten-year government bond was around 4.2%. Last week, the Fed lowered its benchmark rate by 25 basis points to a range of 3.5% to 3.75%, and Chairman Powell emphasized concerns about weak hiring at a press conference on Wednesday, after which yields fell back from recent highs. Against this backdrop, traders are building options positions to profit when market sentiment shifts to expect a rate cut in the first quarter. Currently, the market has not fully priced in the expectation of the next rate cut before mid-year, with the second rate cut expected in October. Data is key All this intensifies market attention on the upcoming data release, which will cover the situation in November and part of October. According to a median forecast in a survey, non-farm payrolls in November may increase by 50,000. Last month's delayed data showed a... For Kevin Flanagan of WisdomTree, the employment report released this week may be relatively light in substance due to the complications in data collection caused by the government shutdown. This has led him to shift his focus to the reports to be released before early next month and the Fed's policy decision on January 28. "The threshold for the Fed to cut rates at the January meeting has been raised," said Flanagan, director of fixed income strategy at the company. "We need to see a clear cooling trend in the employment report." Strategist Ed Harrison said, "To continue the upward trend in bonds, the employment report on December 16 will be the next data point to watch. Given the widespread expectation of a 50,000 increase in non-farm payrolls, a decrease in employment numbers may help sustain the uptrend and bring the first fully priced rate cut expectation forward from June to April." Flanagan said that if the November data is close to the level in September, it may trigger selling, pushing the yield on the ten-year government bond higher to 4.25%. He also believes that the Fed's rate cut cycle is nearing its end, as research shows that 3.5% is the so-called neutral rate, which neither stimulates nor restricts the economy. This view is echoed by Powell's comments last week, as he said the Fed's benchmark interest rate is now within the "broad range of estimates" for the neutral rate, which to some extent emphasizes the limited room for further policy easing. According to an indicator in the swap market, traders expect the Fed to cut rates to around 3.2% at the end of this rate-cut cycle. If the Fed basically remains inactive in the face of persistently high inflation, the US bond market may not experience a bull market that brings substantial total returns in 2026, but instead it may exhibit more of a range-bound pattern, with most returns coming from around 4% coupon payments. New Chairman Effect There are also divisions among Fed officials on the policy path, and like investors, they are waiting for the data to indicate the direction. Chicago Fed President Gulsbee, who voted against the rate cut last week, said on Friday that he voted against the rate cut because he wanted to see more inflation data. Another major event is on the horizon: Powell's term is set to end in May next year, and with President Trump's strong pressure for a significant rate cut, investors' focus may soon shift from economic data to Powell's successor. Currently, Trump's selection process is nearing completion. "Regardless of whether the economy is slightly overheated, the appointment of a new chairman will mean the Fed is more inclined to be dovish," said Janet Rilling, head of fixed income team at Allspring Global Investments. "The job market could become an excuse for a rate cut," she said. "We do not expect unemployment to rise significantly, but even if the job market is slightly weak, it could be a reason for a rate cut."