The US bond market surged on Friday after Jerome Powell indicated that the Federal Reserve is likely to resume reducing interest rates as early as next month. The central bank chief’s comments suggest the Fed is prepared to end its eight-month pause, citing downside risks to the labour market. This led to a jump in Treasury bonds, widening the gap between short- and long-term yields by the most in four years, a typical market response to a more dovish Fed stance.
Despite the positive reaction, some doubts linger about the extent of future rate cuts. Futures traders currently see an 80 per cent chance of a quarter-point cut at the September 17 meeting. Even with recent gains, bond yields have not yet fallen below the lows seen earlier this month, as investors await upcoming employment and inflation data before the next meeting.
The restrained response reflects the challenges facing the Fed, which is balancing a softening labour market against the risk of rising inflation from President Trump’s tariffs. Upcoming data, including the Fed’s preferred inflation gauge, may reveal continued price pressures. Additionally, auctions of two-, five- and seven-year bonds will test investor demand. There remains the possibility of a repeat of last year when the Fed paused policy easing due to unexpected economic strength.
According to Gregory Peters, co-chief investment officer at PGIM Fixed Income, Powell’s comments solidify market expectations of a September rate cut. However, the outlook for the next six months remains uncertain, with mixed economic data likely to keep the bond market on edge. The policy-sensitive two-year yield fell sharply on Friday, and interest-rate swaps indicate traders are pricing in two quarter-point reductions by the end of the year.
