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Fed set for cut with jobs cooling, inflation sticking, bond market guessing

As job growth cools and inflation stalls, the Federal Reserve is expected to cut interest rates later this week. Still, government bond yields are showing that few have confidence over where the central bank may be heading next.

The Fed on Nov. 7 will likely approve a reduction of 25 basis points to its benchmark interest rate, after cutting by 50 bps in September, the first drop since the early days of the COVID-19 pandemic in 2020.

The benchmark 10-year Treasury yield has climbed nearly 70 bps since the Fed's September cut, recovering a pullback early Nov. 1 after the government reported that US jobs increased by only 12,000 in October, the lowest number since jobs declined in December 2020. Employment growth in October was well below the monthly average of 188,000 jobs created through the first nine months of 2024. October's employment data, however, was likely skewed by the impacts of Hurricanes Helene and Milton, as well as The Boeing Co. strike that caused a 44,000 job decline in the transportation equipment manufacturing sector, the US Bureau of Labor Statistics reported.

"I don't think the [jobs] report moves the needle much for the Fed," said Shannon Grein, an economist with Wells Fargo. "As expected, the October report is very noisy because of the storms and strikes, which leads me to want to look somewhat past it."

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In addition, unemployment, which can paint a clearer picture of the labor market, remained unchanged at 4.1%, signaling that the labor market has yet to be substantially hindered by the Fed's earlier efforts to slow the economy with the highest interest rates in more than two decades.

"The labor market is cooling down, but I wouldn't call it cold," said Oren Klachkin, a financial market economist with Nationwide. "I'd characterize it as a return to normal. Conditions are much healthier now after the post-COVID frothiness."

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The jobs report followed the Oct. 31 release of September inflation data. The data showed that while the headline personal consumption expenditures (PCE) index slowed to 2.1%, from 2.3% a month earlier, the "core" PCE index, which removes volatile food and energy prices, remained at 2.7%, where it has been since July. The Fed wants core inflation to be 2%.

"This is the preferred inflation metric used by the Fed and it remains too high," said Gary Brode, managing partner with Deep Knowledge Investing. "That, combined with continued stimulus spending and rate cuts, makes us think we'll see higher future inflation. We expect the bond market will understand this and that yields on longer-term Treasurys will rise."

Bond market view

Stubborn inflation has triggered an increase in longer-dated government bond yields, which move opposite prices, on the growing view that the Fed's cuts will be smaller and longer range than initially anticipated.

With consumer confidence still high, consumption at the highest levels since early 2023, and the jobs market still holding on, the Fed will see little need to cut rates much more in the near term, said Althea Spinozzi, head of fixed income strategy at Saxo Bank.

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The benchmark 10-year Treasury yield has surged as the bond market adjusts its rate-cutting cycle expectations, with investors now expecting a higher federal funds rate at the end of 2025 than predicted just a few weeks prior.

"To be clear, progress has been made, but the question of how much the Fed can reasonably ease much more from here requires greater legitimacy," said Arnim Holzer, global macro strategist at Easterly EAB Risk Solutions.

While these views continue to adjust, the election could also significantly alter the direction of yields. A Republican victory will likely push the 10-year yield to 5% by year-end, as much of the policy goals of former President Donald Trump are viewed as boosting inflation, while a victory by Vice President Kamala Harris could push yields down to 3.6%, Spinozzi said.

"However, given the persistently high fiscal deficit, it's unlikely that yields will remain below 4% in the long term, even in the case of a Kamala victory," Spinozzi said.