Is the Fed signaling a pause in rate cuts? Tonight reveals the final clues for next week's actions by the Federal Reserve

Investors who have been hedging against further selling of U.S. Treasuries are preparing for volatility as the U.S. October non-farm payroll report, impacted by hurricane strikes, will be released on Friday. This report will provide the final clues for the Federal Reserve's policy decision next week.

After ending October with the worst monthly performance in two years, U.S. Treasuries showed little change in early Asian trading on Friday. With just a few days left until the election and the Federal Reserve meeting, the measure of daily yield volatility reached its highest level in a year. Traders are preparing for further declines over the next three weeks, which could push the 10-year Treasury yield up to 4.5%, while the current yield is around 4.3%.

Jack McIntyre, a portfolio manager at Brandywine Global Investment Management, stated that this pricing makes it “hard for the market to ignore” evidence of a strong U.S. labor market in the government data released on Friday. While fund managers might interpret weak data as a result of strikes and storms, a strong employment report would relieve pressure on policymakers regarding interest rate cuts.

He said, “I don’t think the Federal Reserve likes to surprise the market too much.” McIntyre expects a 25 basis point rate cut at next week’s meeting, which aligns with the expectations of most economists surveyed by Bloomberg, but anticipates they will send a hawkish message, “indicating that they won’t cut rates again for a while.”

In the past month, the sell-off in U.S. Treasuries has pushed yields up by about 60 basis points, partly due to unexpectedly strong employment data in September. Since then, volatility has increased due to the upcoming showdown between Trump and Harris on November 5, as well as uncertainty regarding the Federal Reserve's policy path.

The closely watched U.S. bond market volatility index—the ICE BofA Move Index—closed this week at its highest point of the year, indicating that traders are bracing for increased turbulence. A notable trade on Thursday included a $10 million premium bet on volatility through options linked to the secured overnight financing rate.

Traders believe there is about a 90% chance the Federal Reserve will cut rates by 25 basis points next week. Swap rates are expected to total about 117 basis points in cuts over the next 12 months, a reduction of about 67 basis points from expectations at the beginning of October. 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 Treasury yield will reach 4.4% before November 22, with the most popular put option strike target rising to 4.5% Greg Wilensky, head of the U.S. fixed income division at Janus Henderson Investors, stated that while the employment report for October is unlikely to change market expectations for the Federal Reserve's decision in November, the data could still "alter market expectations for the rate cut path during future meetings."

Traders will focus on the unemployment rate, with economists predicting it will stabilize at 4.1%. Strong data will bolster the bond market's expectations for a potential pause in rate cuts early next year.

Ian Lyngen, head of U.S. interest rate strategy at BMO Capital Markets, said in a report: "While the Federal Reserve is likely to cut rates next week, skipping January and instead cutting at a pace of 25 basis points each quarter remains the path of least resistance, aligning with our expectations and the currently relatively consistent view."