(Bloomberg) -- US bond investors have been piling into bets that President Donald Trump’s tariffs will slow the world’s largest economy and force the Federal Reserve to lower interest rates.
Ahead of Friday’s jobs report, money markets are pricing in almost four quarter-point rate cuts in 2025, one more than was anticipated before Trump’s big tariff announcement last month. Meanwhile, data from Wednesday has shown rising long positions on shorter-dated US Treasuries, a bet that the hit to economic growth from the levies will be bigger than its inflationary impact.
Yet the expectations of a sharp slowdown are also subject to ongoing reality checks from economic data: On Thursday, traders rushed to unwind some of their bets on rate cuts after a manufacturing survey came in stronger than anticipated. The tense atmosphere increases the focus on April’s non-farm payrolls report, which will offer an early glimpse into how the tariff uncertainty is playing into the labor market.
“Concerns over much weaker growth are more than offsetting the near-term upside risks to inflation from tariff hikes when market participants weigh up the implications for Fed policy,” said Lee Hardman, a strategist at MUFG.
The big question for bond investors is whether and if the economic pessimism that has been seen in recent surveys will seep into top-tier measures of employment and consumer spending. US consumer confidence fell in April to an almost five-year low, while a gauge of US manufacturing activity shrank in April by the most in five months.
Signs of economic weakness have driven a rally in shorter-dated US Treasuries this month. That’s steepened the yield curve, with two- and five-year notes outperforming 30-year bonds in April by the most since early 2023. Treasury yields fell one to three basis points across the curve on Friday, with the 10-year yield trading at 4.20%.
Complicating matters for the economic outlook is uncertainty over what tariffs will eventually be instated and when, as US negotiations with key trading partners are underway or being planned. On Friday, China said it is assessing the possibility of trade talks after weeks of stalemate, while Japan said discussions will likely gain momentum in mid-May.
Japanese Finance Minister Katsunobu Kato even hinted at the possibility of using its vast US Treasuries holdings for leverage, although it’s unclear how serious he was about the idea. With some $1.1 trillion in holdings, investors in the East Asian nation are the biggest overseas owners of US debt.
Hard Data
For now, Fed officials have been waiting to see what the ‘hard’ data reveals, while remaining an guard against the possibility that tariffs will push up inflation. Speaking last week, Fed Governor Christopher Waller said that he’d support rate cuts if there’s a significant rise in unemployment, which could happen if Trump reinstates more aggressive tariff levels and firms begin laying off more workers.
“The labor market slowing down is necessary for the Fed to continue their easing process,” said Gargi Chaudhuri, chief investment and portfolio strategist, Americas at BlackRock.
While a weaker jobs print for April would be “a step in that direction,” she said the Fed needs to see further weakness beyond one piece of data. “They have to take the totality of the data and I don’t think one weak data print will be sufficient for them to hint at, or continue their rate cutting cycle.”
The data due Friday offer the first look at the US labor market since Trump’s tariff announcement on April 2. The surveys behind the report were conducted in the second week of April, when the president put some levies on hold and sharply raised those on China goods, creating heightened uncertainty among businesses.
The Fed is currently observing a communications blackout ahead of its meeting beginning on May 6. Traders are betting on around four quarter-point cuts in 2025, with the first likely in June. As recently as mid-March, only two cuts were priced in for the year.
“If we start to see the economy turn in a meaningful way,” that sets the stage for the Fed to react “and probably quite forcefully,” later this year, Michael Cudzil, portfolio manager at Pimco told Bloomberg Television on Wednesday. Pimco has been increasing its exposure to the belly of the Treasury curve, between the five and 10-year maturities, said Cudzil.
Economists expect the jobs report to show 135,000 new positions in April compared to 228,000 in March. Most, however, believe the data will only offer a limited insight into the impact of higher US tariffs. Even if the report comes in strong, investors may view the data as backward-looking and continue to expect layoffs in the coming months.
The April data will be the “last solid reading before the storm,” a Bloomberg Economics team including Anna Wong wrote. “The labor market may begin to deteriorate more visibly as soon as May.”
An options trade focused on price action around the payrolls event — the one-day Treasury 10-year options straddle that expires at the end of Friday — is currently implying a roughly nine basis point move in the 10-year yield for the session, broadly in line with prior payroll readings.
In Treasury futures, open interest, or the amount of risk held by traders, has risen sharply over recent sessions after the selloff that initially greeted the tariffs announcement. In the five-year tenor, open interest has climbed to the most on record since the first data collection in the early 1990s.
(Adds detail on jobs report in 12th paragraph, updates prices.)
