US Bonds Slide as Strong Jobs Data Fuels Bets on 2026 Fed Hike

Traders work on the floor of the New York Stock Exchange. Photo by Michael Nagle /Bloomberg

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(Bloomberg) — Bond traders fully priced in a Federal Reserve interest-rate hike by the end of this year after US job growth topped all forecasts in May, spurring yields higher in the $31 trillion Treasuries market.

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Two-year yields, which are most sensitive to changes in US central bank policy, jumped as much as 13 basis points to 4.17%, its biggest one-day rise since President Donald Trump shocked markets with sweeping tariffs last April. Interest-rate swaps indicated traders expect a quarter-point Fed hike by the December policy meeting, with a roughly 60% chance of a move in October.

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The selloff in the bond market and recalibration of Fed wagers reflected growing confidence that the Fed, under Chairman Kevin Warsh, will need to raise borrowing costs to contain inflation that is running above target.

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“The whole narrative has changed for the Treasury market and the Fed,” said Kevin Flanagan, head of investment strategy at WisdomTree. 

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The US government bond market has undergone a profound shift since late February, when the US attack on Iran led to a surge in oil prices and in both actual and expected inflation. That annihilated wagers on Fed rate cuts this year and forged a consensus that the next move will be a hike. 

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On Friday, the market’s hawkish expectations were reinforced by better-than-expected US labor-market readings. Nonfarm payrolls increased 172,000 last month after upward revisions to the prior two months, according to Bureau of Labor Statistics data. The unemployment rate held steady at 4.3%.

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The figures pushed yields across maturities. Five-year yields advanced as much as 11 basis points, while 10-year yields were up as much as eight basis points to 4.55%. The market was on course for its biggest weekly loss since mid-May, while the dollar rose. 

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Flows in Treasury options after the data, meanwhile, featured buying of July 10-year calls, a position that looks to target a yield drop in the sector to around 4.4% within three weeks time, a period that covers US inflation data and the Fed meeting. 

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“The question is: Will the Fed get out ahead of where markets are pricing, or are markets going to try to push the Fed,” Jeffrey Rosenberg, senior portfolio manager at BlackRock, said on Bloomberg Television. “So far, it’s the latter.”

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That leaves policymakers, when the Fed meets for the first time under the leadership of Warsh this month “playing catchup,” he said. 

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Consumer-price figures due Wednesday loom as the next major catalyst for policymakers and investors alike. Swaps tied to the report show traders anticipate a roughly 4.3% annual increase — which would be the steepest since April 2023 — as energy prices remain elevated amid the stalemate in the Iran war.

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To WisdomTree’s Flanagan, policymakers will need to take a more balanced approach to policy by removing its bias toward rate cuts when it next meets June 16 and 17. Several Fed officials have indicated they can’t support cuts with US inflation gauges exceeding the bank’s 2% target by a widening margin, and have in recent weeks begun to sound more open to higher rates.