Traders Bet the Fed Will Fuel Winning Streak as Bonds Rally

Despite a turbulent first half of the year, U.S. bond traders managed to close it on a high note and are now looking ahead with renewed optimism. Following three consecutive weeks of gains, investors are eyeing further profits, with this Thursday’s employment report standing out as a potential market mover.

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The Treasury market is wrapping up its strongest monthly performance since February and its best first-half return in five years. This comes in spite of numerous headwinds including unpredictable policy moves from former President Donald Trump, tariff concerns, geopolitical unrest, and a Moody’s credit downgrade. While trade negotiations are still a dominant theme, some of the other pressures that had weighed on markets have faded as June winds down.

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Bond yields are currently hovering near their lowest levels in two months, with the benchmark 10-year Treasury note yielding about 4.28%. Investors have largely brushed aside implications of Trump’s tax reform plan, which is set for a Senate vote soon. Instead, they are focusing on the Federal Reserve, which markets expect will cut interest rates at least twice before the year ends.

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“There’s a general leaning in the market toward Fed rate cuts, and there’s also a fear of missing out when the central bank resumes easing,” said George Catrambone, head of fixed income at DWS Americas. He’s been increasing exposure to longer-dated bonds, such as the 30-year Treasury, particularly after recent auctions demonstrated strong foreign interest in U.S. debt.

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Earlier this month, the idea of a rate cut in July seemed remote. But now, traders assign nearly a 20% chance to that possibility, while September is considered almost certain for a policy shift. Although Fed Chair Jerome Powell and other officials have urged patience, preferring to wait for clearer economic signals, market participants are positioning for quicker action should labor market data weaken or inflation stay subdued.

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Trading in interest rate options indicates growing anticipation of falling yields and a faster pace of rate cuts. Asset managers are favoring five-year Treasuries, which are well-positioned to benefit if a broader rally continues into 2026.

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“For the Fed to take a more aggressive approach on cuts, we’d need to see weakness in the labor market,” said Vanguard portfolio manager John Madziyire. He finds mid-term Treasuries — those maturing in five to ten years — appealing, especially as signs of economic slowdown grow more visible. “You’re getting paid to take on that rate risk,” he added.

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Thursday’s employment report for June — released a day earlier than usual due to the July 4 holiday — is expected to show a slowdown in hiring, with payroll gains projected to fall to 113,000 from May’s 139,000.

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The unemployment rate is forecast to edge up to 4.3%, a level not seen since 2021. While such numbers wouldn’t necessarily trigger immediate action from the Fed, a notably weaker reading could push policymakers to consider moving sooner.

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“If the job numbers come in soft and inflation still doesn’t reflect any meaningful impact from tariffs, then the July meeting could be on the table,” said Dan Carter, a portfolio manager at Fort Washington Investment Advisors. “But it’s likely to be a close decision, and Powell may prefer to wait until September.”

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Market expectations around rate cuts have shifted repeatedly since December. While the Fed’s median forecast still points to two quarter-point reductions this year, any surprise in this week’s data could affect that outlook. At the same time, mixed messages from the Trump administration regarding tariffs — with a key July 9 deadline looming — continue to keep trade policy in focus.

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Despite June’s rally, yields remain well above their lows from April due to lingering macroeconomic uncertainty. Bank of America recently projected two-year yields ending both 2025 and 2026 at around 3.75%, with the 10-year yield ending 2025 at 4.5%. JPMorgan Chase echoed similar views, forecasting the 10-year yield will reach 4.35% by year’s end. The bank sees the first Fed cut happening in December, followed by three more in early 2026.

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In early Monday trading in Asia, Treasury yields were steady across maturities.

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Yet, some investors worry the Fed could be falling behind the curve. Powell acknowledged in testimony last week that the central bank could move sooner if inflation and employment data weaken significantly. He also noted that jobs data often lags economic changes — a detail not lost on bond investors.

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Matthew Hornbach, Morgan Stanley’s global head of macro strategy, told Bloomberg TV that they expect the 10-year yield to drop to 4% by year-end and potentially fall below 3% by the end of 2026. His firm doesn’t predict any cuts in 2025 but sees aggressive easing next year once tariff-related inflation fades and labor market weakness becomes more pronounced.

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Jamie Patton of TCW Group added that mixed views among Fed officials raise the likelihood of a policy error. She prefers two- and five-year notes, which stand to benefit most if the Fed ends up cutting more than currently expected.

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“With over a dozen policymakers steering the Fed and little consensus on direction,” Patton said, “there’s a real risk of a rough landing if they can’t agree on where to go.”

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