U.S. Treasury yields rose Tuesday as fears that the U.S. economy is quickly entering a recession were seen as overdone, while safe haven demand for U.S. bonds also ebbed as stock markets recovered.
Yields tumbled to a more than one-year low on Monday as investors repriced for rapid interest rate cuts by the Federal Reserve following an unexpected increase in the unemployment rate and fewer than expected job gains in July’s employment report on Friday.
San Francisco Fed President Mary Daly said on Monday that many details in the jobs report leave "a little more room for confidence that we're slowing but not falling off a cliff.”
Chicago Fed President Austan Goolsbee also cautioned against taking too much of a signal from the global market sell-off, noting it stemmed in part from the Bank of Japan's decision last week to raise rates, as well as increasing geopolitical tensions in the Middle East.
“We had two shocks really in the last week," said Guy LeBas, chief fixed income strategist at Janney Montgomery Scott in Philadelphia.
"The first being a downside economic shock evident from Friday's nonfarm payrolls report and hints of deceleration in the labor market. The second shock being a positioning shock related to divergent central bank policy between the Bank of Japan and the world's other major central banks,” LeBas said.
“You put those two things together and you get a recipe for some choppy action,” LeBas added. But, “the idea of pricing in a very high probability of an intermediate rate cut at a time when the economy is still growing and there's no obvious crisis is pretty goofy.”
U.S. services sector activity on Monday also boosted confidence in the economy as it rebounded from a four-year low in July amid a bounce back in new orders and the first increase in employment in six months.
Traders are now pricing in a 75% chance the Fed will cut rates by 50 basis points at its next scheduled policy meeting in September, and a 25% chance of a 25 basis point reduction. A 50 basis point cut was fully priced in on Monday, with a 75 basis point cut also seen possible, according to the CME Group's FedWatch Tool.
Traders had begun positioning for a possible emergency rate cut before September.
Yields on interest rate sensitive two-year notes were last up 5.3 basis points at 3.938%, after getting as low as 3.654% on Monday, the lowest since April 2023.
Benchmark 10-year note yields rose 3.9 basis points to 3.822%, after reaching 3.667% on Monday, the lowest since June 2023. The gap between two- and 10-year Treasury notes was last at minus 12 basis points, after reaching 1.50 basis points on Monday. It was the first time it has turned positive since July 2022.
Japanese leaders rushed on Tuesday to assuage concerns about the sharp swings in the country's financial markets, with the prime minister urging calm and senior finance officials convening an emergency meeting to discuss the global stock market sell-off.
A sharp rally in the Japanese yen has prompted traders to unwind popular trades that involved selling the Japanese currency and buying U.S. assets.
Yields may be pulled higher by new Treasury supply this week. The Treasury Department will sell $125 billion in coupon-bearing debt, including $58 billion in three-year notes on Tuesday, $42 billion in 10-year notes on Wednesday and $25 billion in 30-year bonds on Thursday.
Safe haven demand could return, however, with rising geopolitical tension in the Middle East posing a risk to markets.
Lebanon's armed group Hezbollah launched a series of drone and rocket attacks into northern Israel on Tuesday but warned that its much-anticipated retaliation for Israel's killing of a top commander last week was yet to come.