The market may face an information vacuum? The risk of a US government shutdown is increasing, and the outlook for this week's US Non-farm Payrolls (NFP) data is concerning.

Written by: White55, Mars Finance

Federal Reserve officials have sent mixed signals regarding the outlook for monetary policy, and coupled with the strong performance of some economic indicators, traders have adjusted their expectations for further easing by the Fed.

However, the financial markets are currently facing a more pressing challenge: if the federal government shuts down starting October 1, it could lead to delays in the release of key economic data, including the non-farm payroll report originally scheduled for release on Friday—this is a core indicator viewed by the market as a measure of labor market health.

Previously, the weak labor market prompted the Federal Reserve to implement its first interest rate cut of the year this month. The market currently estimates the probability of a rate cut at the October meeting to be around 80%, but decision-makers may need more weak data to confirm the trend of a sustained cooling in the job market, thereby strengthening expectations for easing policies and maintaining the momentum of U.S. Treasury yields toward their best annual performance since 2020.

James Athey, portfolio manager at Marlborough Investment Management, pointed out: "The non-farm report is a key catalyst driving the market rebound, but even if the data is weak, the threshold for further lowering U.S. Treasury yields has significantly increased." He disclosed that he is currently underweighting U.S. Treasuries.

The 10-year Treasury yield rose to around 4.2% last week, having previously dropped to a five-month low of below 4% on September 17. Although the Federal Reserve had restarted its easing cycle with a 25 basis point rate cut at that time, and some members advocated for a more aggressive 50 basis point cut, the subsequent improvement in initial jobless claims and robust GDP growth data for the second quarter partially reversed market sentiment. Traders slightly adjusted their expectations for the extent of easing, but still generally bet that the Federal Reserve will continue to cut rates by 25 basis points in October and December, with an expected cumulative cut of about 1 percentage point over the next 12 months.

Recent weakness in government employment data has prompted the Federal Reserve to shift towards easing despite inflation remaining above the 2% target. This policy shift supports bond performance, making U.S. Treasuries likely to achieve their best annual returns since 2020. The market predicts that the non-farm payrolls for September, to be released on October 3, will show an increase of 50,000 jobs, a rebound from the average monthly increase of less than 30,000 over the previous three months.

Last week, Federal Reserve Chairman Powell emphasized that the current rate of job growth may have fallen below the balanced level required to maintain a stable unemployment rate, and acknowledged that policymakers are facing the contradictory risks of a slowing labor market and persistent inflationary pressures.

The internal positions of the Federal Reserve are clearly divided: Chicago Fed President Goolsbee warned that tariffs could push up inflation and opposed excessive premature rate cuts; while Governor Bowman believes that inflation is close to the target and supports further easing due to a weakening job market. The options market shows that some investors are betting that the 10-year yield will fall below 4% before the end of November, but a survey of JPMorgan clients shows a sharp increase in short positions, reflecting significant divergence in market expectations.

Sara Devereux, head of fixed income at Navigant Group, stated that the current level of the 10-year yield is basically reasonable, balancing the downside risks of labor market weakness with the upside potential of economic improvement. She revealed that her actively managed portfolio tends to increase holdings in 5-10 year bonds when yields rise to the upper range. The risk of government shutdown also enhances the importance of other alternative data, such as the ADP private employment report on October 1. Although the historical correlation between ADP and official data is unstable, the recent downward revision trend in government data aligns with the weakness presented in private reports. Ed Al-Hussainy, a manager at Columbia Threadneedle Investments, pointed out: "If ADP data is strong, it will open new space for market discussions on the path of interest rates and the timing of rate cuts next year."