Interest-rate swaps now indicate that traders in the $31 trillion U.S. Treasuries market have fully priced in a Federal Reserve interest-rate hike by the end of this year. This shift follows stronger-than-expected U.S. job growth in May, which sent yields climbing across the board.
Market Reaction to Jobs Data
Nonfarm payrolls increased by 172,000 in May, with upward revisions to the prior two months, marking the strongest three-month advance in over two years. The unemployment rate held steady at 4.3%. In response, the two-year Treasury yield—most sensitive to Fed policy—jumped as much as 11 basis points to 4.15%, the highest level this year. The 10-year yield rose six basis points to 4.53%, and the dollar strengthened.
Rate Hike Expectations
Interest-rate swaps show traders bracing for a quarter-point increase by the December policy meeting, with a roughly 60% chance of a move as early as October. This marks a dramatic reversal from earlier expectations of rate cuts, which were abandoned after the U.S. attack on Iran in late February triggered a surge in oil prices and inflation expectations.
Jeffrey Rosenberg, senior portfolio manager at BlackRock, noted on Bloomberg Television: "The question is: Will the Fed get out ahead of where markets are pricing, or are markets going to try to push the Fed? So far, it's the latter." This leaves policymakers, meeting later this month under new Chairman Kevin Warsh, "playing catchup," he added.
Bank Forecasts Shift
Most major Wall Street banks have abandoned forecasts for rate cuts in 2026, though many still expect at least one cut in 2027. Fed officials have recently sounded more open to higher rates, with several indicating they cannot support cuts while inflation exceeds the 2% target by a widening margin.
John Briggs, head of U.S. rates strategy at Natixis North America, commented: "Now we have jobs showing some recent acceleration, so the market has a second reason to consider hikes, especially in combination with inflation risks that remain with the Strait of Hormuz still closed."
Fed Policy Context
The Fed lowered rates three times last year due to concerns about employment market weakness, then paused as the economy stabilized. The key rate has been in a range of 3.5% to 3.75% since December. A reading of the U.S. consumer price index next week will provide the next major input for traders and Fed officials ahead of the June 16-17 policy meeting.
Tracy Chen, portfolio manager at Brandywine Global Investment Management, said: "The number is strong and shows the job market is on the mend and inflation should be the focus of the Fed. The massive bear flattening of the curve just echoes that. We are at a juncture when inflation rate matches unemployment rate, the Fed may be behind the curve."
Bloomberg strategist Edward Harrison noted: "The headline numbers and backward revisions in the May U.S. payrolls figures immediately vaulted 30-year yields back over five percent. With the belly of the curve catching up on real yields, also expect continued curve flattening."
