The U.S. Economy Shows Resilience, US Treasury Yields May Rebound After Rock Bottom | Moomoo Research

Since August, changes in U.S. employment and inflation data have led to a continuous strengthening of market expectations for a Federal Reserve rate cut. As of September 2nd, the yield on 10-year U.S. Treasury bonds has dropped by 62 basis points from its peak at the beginning of July, falling to 3.862%. The significant decline in U.S. Treasury yields is primarily due to disappointing non-farm employment data in July, with the unemployment rate rising to 4.3%; at the same time, U.S. inflation continues to slow down, with the U.S. CPI grew by 2.9% year-on-year in July, and the core CPI grew by 3.2% year-on-year, both 0.1 percentage points lower than the previous values.

However, with the release of more economic data, we find that the U.S. economy still has resilience, the downside space for short-term Treasury yields is limited, and the rate cut expectations have been digested. Considering that the sharp rise in the unemployment rate in July was due to short-term disruptions caused by extreme weather events, employment data in August may warm up. At the same time, the strong performance of consumption data and the upward revision of GDP growth further highlight the resilience of the U.S. economy, and the Federal Reserve has no incentive to make a substantial rate cut.

Under the interwoven influence of these factors, this article will delve into employment, inflation, and the Federal Reserve's policy stance to analyze the possible direction of future rate cuts in the current economic environment, providing trading strategies for everyone.

Data from the U.S. Bureau of Labor Statistics shows that the U.S. non-farm employment data in July was unusually weak: the number of new non-farm employment positions was only 114,000, far less than the market expectation of 175,000, and the absolute value scale reached the lowest level since February 2021; the unemployment rate rose to 4.3%, and the unemployment rate has been higher than the previous value for four consecutive months.

However, there is another reason behind these poor employment figures. On July 8th, local time in the United States, Hurricane "Beryl" landed in Texas as a Category 1 hurricane, directly leading to an increase of 249,000 in the number of temporary layoffs in July. About 2.7 million households and businesses in the Houston area were without power for several days, and even more than ten days after the hurricane made landfall, power supply had not been fully restored.

With the receding impact of extreme weather, the number of initial and continued unemployment claims decreased by 17,000 and 3,000 respectively in the week of August 17, indicating that non-farm data in August is expected to improve month-on-month, suggesting that the labor market conditions are becoming stable.

Therefore, if the employment data warms up in August, the Federal Reserve may adopt a more moderate and cautious attitude when considering rate cut policies.

From the perspective of inflation data, overall U.S. inflation has slowed down, which is basically in line with expectations. On Friday, August 29, the U.S. Bureau of Economic Analysis announced data showing that the core PCE price index (excluding the more volatile food and energy prices) in July rose by 2.6% year-on-year, equal to the previous value, slightly lower than the expected 2.7%; it increased by 0.2% month-on-month, equal to the expected and previous values. In addition, the core PCE's annualized growth rate over three months is 1.7%, the lowest growth rate this year.

Although inflation has slowed overall, the possibility of a rebound at the end of the year needs to be vigilant. Due to the low inflation base effect last year, coupled with the possible mild economic recovery after the rate cut in September, inflation data at the end of this year may fluctuate. Assuming inflation rebounds, the Federal Reserve may adopt a moderate rate cut strategy to support economic growth and balance inflation risks.

In addition to inflation data, we also need to pay attention to the health of U.S. consumption and the economy.

From the retail data, U.S. consumption remains strong. Data released by the U.S. Department of Commerce on August 15 showed that the retail sales data in July significantly exceeded expectations, with a month-on-month increase of 1.0%, far higher than the previous value of -0.2% and the market expectation of 0.3%. This not only alleviated market concerns about a U.S. economic recession but also showed signs of a recovery in the consumer market. At the same time, GDP growth exceeded expectations. The revised second-quarter GDP growth rate was 3.0%, higher than the initial value of 2.8%, indicating that the economic foundation is relatively solid, and there is still growth momentum.

Therefore, the strong growth of U.S. retail data and the upward revision of GDP growth have proven that the overall stability of the U.S. economic fundamentals, the U.S. consumer market provides strong support for economic growth, and in such an economic context, market concerns about a significant economic downturn have been alleviated, and the possibility of the Federal Reserve making aggressive rate cuts has also been reduced.

At the Jackson Hole Annual Meeting on August 23, Federal Reserve Chairman Powell's speech implied that policy adjustments would be made, "It is time to adjust the policy. The direction of action is clear, and the timing and pace of rate cuts will depend on new data, the evolving outlook, and the balance of risks." This statement almost set the tone for the rate cut action in September, further consolidating the market's expectations for a rate cut.

Although the Federal Reserve believes that the timing for a rate cut is ripe, they have not shown support for substantial rate cuts. There are two main reasons behind this:

1. Managing market expectations. Under the shadow of concerns about an economic recession, the Federal Reserve must manage market expectations through prudent statements to avoid the uncontrolled spread of pessimistic sentiment.

2. Lack of momentum. Given the strong resilience shown by the U.S. economy, the non-farm employment data in August is expected to show positive changes, signs of a recovery in the consumer market, and the short-term risks of inflation are still controllable. From the current economic fundamentals, there is no sufficient reason to support substantial rate cuts.

As of September 2, CME data shows that the market is currently pricing a 50bp rate cut in December at about 44.8%, expecting a cumulative rate cut of more than 100bp within the year, and the market's expectations for a rate cut are relatively aggressive. Through the multi-dimensional analysis of U.S. employment, economic fundamentals, and the Federal Reserve's stance mentioned earlier, it can be judged that the current rate cut expectations are too aggressive, and Treasury yields may have touched a stage low.

Figure: Target Rate Probability For 18/12 2024 Fed Meeting

Source: CME

Based on the above analysis, in the short term, U.S. Treasury rates may be close to a stage bottom. With the improvement of employment data in August, the recovery of consumption, and the continuous improvement of the fundamentals, the probability of a substantial rate cut is reduced, U.S. Treasury yields may face upward pressure in the short term, and the downward pressure on the U.S. dollar index may be alleviated. It is expected that the first rate cut of 25 basis points will occur in September, and a cumulative rate cut of 75 basis points will be achieved within the year.

Investors are advised to be cautious about going long on U.S. Treasury bonds in the short term and to be alert to the risk of a rebound in Treasury yields. In the long term, the continuous growth of U.S. Treasury bond prices under the trend of interest rate cuts is still optimistic.

In summary, although the July employment data was poor due to the impact of extreme weather, the recovery of consumption and the upward revision of GDP growth indicate that the U.S. economic fundamentals still maintain a certain resilience. Looking forward, the Federal Reserve is likely to remain cautious in monetary policy to ensure a smooth transition of the economy. Therefore, U.S. Treasury yields may have touched a stage bottom in the short term, and there is a need to be alert to the rebound of yields. The U.S. dollar index may also get a breather from the previous downward trend. In such an environment, investors should be patient, not be confused by short-term market fluctuations, but focus on the long-term trends of the economy and the robustness of the fundamentals.