US Two-Year, Five-Year Yields Fall to Lowest Levels Since May

The Marriner S. Eccles Federal Reserve building in Washington, DC. Photographer: Al Drago/Bloomberg

(Bloomberg) -- US short-dated bonds yields fell to their lowest levels in more than three months, reflecting conviction among traders that the Federal Reserve will cut interest rates in September.

The two-year yield, among the most sensitive to changes in monetary policy, fell about two basis points to 3.65%, the lowest level since May 1. It’s down about 30 basis points since July 31, before tumbling on weaker-than-expected July employment data released the next day. The five-year note’s yield also reached the lowest level since May 1.

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The gains have been underpinned by expectations that Fed officials will lower borrowing costs for the first time this year at their September meeting — a move that President Donald Trump has repeatedly demanded. Treasury Secretary Scott Bessent added to that call on Wednesday, suggesting that a 50 basis point move could be appropriate.

Interest-rates swaps are now nearly fully pricing in a quarter-point move next month, with some traders piling into bets on it being 50 basis points.

“One of the strategies they are doing is to shift the window to what is acceptable,” Henry Allen, macro strategist for Deutsche Bank AG, said in an interview with Bloomberg TV. In contrast to the large moves that Bessent and Trump are calling for, “suddenly a 25 basis point rate cut seems fairly modest and achievable.”

A fresh spate of economic data later Thursday, including producer prices and initial jobless claims, will offer further evidence on the health of the US economy.

The 10-year yield has fallen to around 4.21%, about 15 basis points lower since late July. It declined nearly three basis points Thursday.

Market sentiment has shifted dramatically from two weeks ago, when expectations for a September cut were less than 50%. That started to change after the weak July jobs report, which led to a fresh round of calls by the Trump administration for the Fed to bring borrowing costs down.

There have also been bets that the Fed will reduce rates by more than 25 basis points. Traders added some $2 million in premium on Tuesday to a position in the Secured Overnight Financing Rate (SOFR) that would benefit from such a move.

If the Fed were to cut by half a point, both the front-end and longer tenors would rally, according to George Goncalves, head of US macro strategy at MUFG.

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While that might seem counterintuitive given the threat posed by sticky inflation, a move of that magnitude would send a signal that the Fed has delayed adjusting policy too long. That would likely spur demand for the safety of US Treasuries as investors dump riskier assets.

“If the Fed starts cutting that fast, after being in wait-and-see mode and holding off this long, that means they are behind the curve,” Goncalves said.

(Updates yield levels. A previous version was corrected to show Bessent said a 50bp rate cut could be appropriate in September, rather than December.)

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