By Davide Barbuscia
NEW YORK A wild week in Treasury markets is set to culminate with the U.S. payrolls report on Friday, and some investors believe benign data could bring calm after a selloff pushed government bonds to pre-financial crisis levels.
Bond yields, which move inversely to prices, have surged due to expectations that interest rates will remain high because of a resilient economy, as well as concerns over rising fiscal deficits and increases in U.S. government bond supply.
The selloff, which saw 10-year and 30-year yields hit their highest levels since 2007 earlier in the week, paused on Wednesday after the ADP National Employment Report showed U.S. private payrolls, one measure of U.S. jobs growth, increased less than expected last month.
Some market participants believe a weaker-than-expected September employment reading on Friday may be seen as further evidence that the Federal Reserve’s 525 basis points of tightening are starting to dent the labor market, potentially bolstering the case for policymakers to begin cutting rates sooner than expected - or at least forego another interest rate hike later in the year.
"An unexpected softening in payrolls could pour some cold water on the selloff, allowing the market to retrace a portion of recent weakness," said Gennadiy Goldberg, head of U.S. Rates Strategy at TD Securities USA.
Futures tied to the Fed's key policy rate show traders pricing in a 19.6% chance of an interest rate increase in November, compared with 28% before the ADP data, according to CME Group data.
Spencer Hakimian, CEO of Tolou Capital Management, a New York-based macro hedge fund, said a benign report on Friday could spark a turnaround in battered Treasuries.
"It’s quite possible that soft payroll numbers can reverse the trend in Treasury term premium and cause a sharp rally in Treasuries, as markets price out ‘higher for longer’ and begin to price in a recession, which is looking increasingly likely,” he said.
The ICE BofA MOVE Index, a measure of expected volatility in U.S. Treasuries, hit its highest level since the end of May earlier this week.
Of course, economic data has more-often-than not surprised to the upside in recent months. A strong reading could boost expectations of higher interest rates, further exacerbating the weakness in Treasuries.
Andrew Brenner, head of international fixed income at National Alliance Securities, estimated that 10-year yields, which stood at around 4.7% on Thursday, could go as high as 5% should payrolls largely exceed expectations. That would be a level not seen since 2007.
Conversely, much milder data for the market could see the yield fall to as low as 4.25%, he said.
Economists surveyed by Reuters said nonfarm payrolls likely increased by 170,000 jobs last month after rising 187,000 in August. But the wide range of forecasts - from 90,000 to 250,000 - suggests there could be surprises in store.
"If you get either one of those extremes you’re going to reset the pricing that we’re seeing today," Brenner said.
(Reporting by Davide Barbuscia; Editing by Marguerita Choy)