American treasury bond traders are betting on the Federal Reserve raising interest rates, the May non-farm payroll report will be a key test.

The bond market is pricing in a shift in the Federal Reserve's policy direction, and the May non-farm payroll report to be released this Friday will be a key test of whether this bet can hold steady. Outside of the Middle East situation, employment data has become the focus of the market this week. Bloomberg's latest survey shows that the expected increase in non-farm payrolls in May is about 90,000, with an unemployment rate of 4.3%. If the data confirms the resilience of the labor market, coupled with high oil prices and accelerating inflation, the market expects the Federal Reserve to remove its accommodative stance at the June meeting - the first interest rate decision meeting after Chairman Kevin Wash took office. Traders are currently betting that the Federal Reserve will raise rates as early as the mid-2027s, which is in sharp contrast to the previous market expectations that Wash would cut rates as soon as he took office. According to Bloomberg Economics, since the outbreak of the Iran war, the jump in bond yields has tightened financial conditions by about 75 basis points, to some extent substituting for the Federal Reserve's interest rate hikes. Yield volatility at high levels, the market stands at a crossroads. The yield on the benchmark 10-year Treasury note is currently around 4.44%, down from its peak a few weeks ago. Part of the reason is the expectation of a ceasefire in the war, which has led to a softening in oil prices. Last week's government bond auction also showed that demand at current yield levels is still strong. However, the 10-year yield is still about 50 basis points higher than at the end of February. A recent government bond option trade in the market bets that the 10-year yield will surpass 5% in the next few months, a level not seen since 2023. The two-year yield, which is the most sensitive to interest rate expectations, is currently around 4%, also about 60 basis points higher than at the end of February, approaching the upper end of the Federal Reserve's current policy rate range of 3.5% to 3.75%, and the spread with long-term yields continues to narrow. Inflation remains high, and rate hike expectations continue to rise. The core logic supporting the hike bet is the continued higher-than-expected inflation data. Data released last week showed that the Federal Reserve's favorite inflation gauge - the Personal Consumption Expenditures (PCE) price index - rose 3.8% year-on-year in April, far above the officials' long-term target of 2%. Gregory Faranello, head of US rate trading and strategy at AmeriVet Securities, said, "If inflation data remains high and employment growth remains robust, the market may begin to price in a more aggressive rate hike path for the Federal Reserve. Just raising rates once is not enough." More and more Fed officials have publicly stated that they hope the central bank will signal equal possibilities for the next steps of rate hikes and rate cuts. Cindy Beaulieu, Chief Investment Officer of North America at Conning, managing about $190 billion in assets, pointed out: "Global markets, not just US bond yields, are reflecting the same dilemma - how much inflation can be tolerated and when it will threaten growth." Increasing institutional divergence, short-term bonds favored. Facing the high uncertainty of the policy path, institutional investors have shown significant differentiation in their strategies, but short-term bonds are generally favored. George Catrambone, head of fixed income at DWS Americas, said that rising yields are creating headwinds for the US economy, "doing what the Federal Reserve should do." He prefers holding two-year government bonds and buying them when the 10-year yield approaches recent highs. He also warned that high inflation eroding real wages will increase pressure on US consumers and ultimately drag down economic growth. Loren Moran, a portfolio manager at Wellington Management, had previously been "cautious" about government bonds due to the wave of artificial intelligence capital expenditures that could accelerate growth and inflation. However, as yields rise and rate hike expectations increase, her stance has shifted, seeing short-term government bonds as "attractively defensive compared to long-term yields, providing a defensive haven." This week will also see the release of job vacancy data and ADP private sector employment data, these leading indicators will provide important references for the Friday non-farm payroll report and further test the current bet in the bond market. This article is reprinted from "Wall Street See News", GMTEight Editor: Feng Qiuyi.