Will tonight's non-farm payrolls trigger a surge in U.S. Treasury yields? Traders bet on a rise to 4.5%, guarding against further sell-offs

Zhitong Finance has learned that investors who have been hedging against further selling of U.S. Treasuries are preparing for volatility, as the U.S. non-farm payroll report for October, affected by hurricanes and strikes, provided the final clues for the Federal Reserve's policy decision next week. In early Asian trading on Friday, U.S. bonds showed little change, with the monthly performance at the end of October being the worst in two years. With the U.S. elections and the Federal Reserve meeting approaching, an indicator measuring daily yield volatility reached its highest level in a year, as traders prepared for further declines that could push the 10-year U.S. Treasury yield to 4.5% in the next three weeks, while the current yield is around 4.3%.

Jack McIntyre, a portfolio manager at Brandywine Global Investment Management, stated that the positioning makes it "hard for the market to ignore" the evidence of a strong U.S. labor market shown in the government data released on Friday. Although fund managers could interpret the weak data as a byproduct of strikes and storms, a strong employment report would alleviate the pressure on policymakers to cut interest rates.

He said, "I think this Federal Reserve doesn't like to surprise the market." McIntyre expects the Federal Reserve to cut rates by 25 basis points at next week's meeting, which aligns with the expectations of most economists, but he anticipates that the Federal Reserve will send a hawkish signal and "imply that they will not cut rates for the time being."

The sell-off in government bonds over the past month has pushed U.S. Treasury yields up by about 60 basis points, partly due to unexpectedly strong employment data in September. Since then, market volatility has increased due to the approaching U.S. election day and uncertainty regarding the Federal Reserve's policy path. The closely watched ICE-BofA Move Index, which measures volatility in the U.S. bond market, closed at its highest level of the year this week, indicating that traders are paying higher prices to hedge against escalating turmoil. A notable trade on Thursday included a $10 million long volatility premium obtained through options linked to the secured overnight financing rate.

Traders expect about a 90% chance that the Federal Reserve will cut rates by 25 basis points next week, a reduction from the 50 basis points in September. Swap rates are pricing in a total reduction of about 117 basis points from the Federal Reserve over the next 12 months, which is about 67 basis points lower than at the beginning of October.

The cash market has also seen some unwinding. JPMorgan's latest survey shows that as neutral positions increase, clients are reducing both long and short positions.

In the options market, traders have been preparing for further selling. Thursday's fund flows included a $6.5 million premium bet that the 10-year U.S. Treasury yield would be 4.4% by November 22, while the most popular put options targeted a yield rise to 4.5%

Greg Wilensky, Head of U.S. Fixed Income at Janus Henderson Investors, stated that although the non-farm payroll report for October is unlikely to change expectations for the Federal Reserve's decision in November, the data could still "influence market expectations for the rate cut path in future meetings." Traders will focus on the unemployment rate, which economists expect to stabilize at 4.1%. Strong data could support the bond market's expectations for a potential pause in rate cuts early next year.

Ian Lyngen, Head of U.S. Rates Strategy at BMO Capital Markets, noted in a report that while the Federal Reserve may cut rates next week, "skipping January and moving to a quarterly rate cut of 25 basis points remains the path of least resistance, consistent with our expectations and currently a relatively unified view."