Global Rates & FX Views: NFP & refunding review

July U.S. Labor Report Analysis

• Total nonfarm payrolls reported a negative print of -23,000, driven primarily by seasonal factors in local government education and weakness in leisure and hospitality.
• Public sector education employment fell by approximately 50,000; strategists expect this seasonal decline to reverse in August or September.
• Leisure and hospitality employment dropped for the third of the last four months, attributed to higher gas prices dampening recreational travel.
• Construction sectors added 22,000 jobs, linked to ongoing data center build-outs.
• Private payrolls grew by +30,000, suggesting the broader private labor market is near break-even despite the headline loss.
• Average hourly earnings declined significantly, while labor force participation dropped, complicating the labor market picture.
• The unemployment rate fell 0.1% despite lower employment and participation, a divergence strategists characterize as a supply-side shock where out-of-work participants are dropping out of the labor force.
• Wage growth decline is identified as the most "dovish" signal in the report, supporting the Fed's view that the labor market is not a current source of inflation.

Federal Reserve Outlook and Policy Implications

• Strategists advise the Fed that the labor market remains balanced with near-zero break-even job growth, suggesting negative monthly prints are consistent with their internal models.
• Current market pricing reflects a shift toward a dovish stance, with two-year nominal rates down 5 bps and real rates down 8 bps immediately following the report.
• The September FOMC meeting is now priced at roughly 50/50 for a rate hike, down from previous expectations.
• Markets now anticipate approximately 30 bps of total hikes by year-end and 40 bps over the next 12 months, down from prior projections.
• Bank of America Global Research maintains a recommendation for clients to be underweight at the front end of the curve and hold "in flatter" positions, though conviction is slightly reduced pending next week's CPI data.
• Strategists note the market reaction suggests investors believe the Fed lacks the "guts" to hike further, despite equities rising on the "soft" data.
• Aditya Bahl emphasizes that the Fed's reaction function remains opaque; he suggests Chairman Powell would be better served by either speaking more clearly on inflation tolerance or ceasing press conferences to avoid miscommunication risks.
• Fed communication is viewed as a "hall of mirrors" where markets price in the Fed's reaction to data rather than reacting to the data itself.
• Recent communications from Fed officials (e.g., Cook) and an FT article have attempted to reassure markets that the Fed will utilize the Fed Funds Rate (its core tool) to fight inflation if necessary.

Treasury Refunding and Issuance Strategy

• Treasury maintained its forward guidance to keep current coupon auction sizes constant for the foreseeable future, moving in the opposite direction of advice from the Treasury Borrowing Advisory Committee (TBAC).
• TBAC recommended softening language to prepare markets for anticipated coupon growth in fiscal years 2027 and 2028; Treasury instead removed the word "increases" in favor of "changes," creating ambiguity in the directionality of future supply.
• Market participants interpret the Treasury's stance as a certainty of higher future issuance, regardless of the softened language.
• Treasury appears increasingly sensitive to current demand conditions, with strong inflows into money market mutual funds and bills, potentially driving a strategy of higher bill shares and lower weighted average maturities (WAM).
• Despite the policy shift, the market ignored the language tweak, with swap spreads virtually unchanged and 20-year spreads marginally cheaper, indicating the market is "looking through" the guidance.

FX Intervention and the Treasury Market

• U.S. Treasury Secretary Janet Bessent (likely referring to Secretary Bessent or the Secretary of the Treasury coordinating with Japan) is engaging in coordinated yen intervention to prevent bear steepening in the Japanese Government Bond (JGB) curve from spilling over into U.S. Treasuries.
• The intervention utilizes a Federal Reserve swap facility (FEMA repo) allowing foreign authorities to pledge securities for liquidity rather than selling Treasuries directly.
• H-4/1 data from the prior week showed no usage of the FEMA repo facility and an increase in foreign official custodial holdings at the New York Fed, suggesting Treasuries were not sold to fund the intervention.
• The impact of FX intervention on the U.S. Treasury market is deemed limited due to structural changes: foreign official investors now hold only ~10% of Treasuries (down from ~30% a decade ago) and represent a smaller share of auction allotments.
• Recent Japanese interventions did not cause the front end of the Treasury curve to cheapen; instead, spreads richened, indicating the broader buyer base (domestic funds and hedge funds) did not react to headlines with a "buyer strike."
• Strategists conclude that the primary risk from intervention lies not in direct selling, but in whether such headlines trigger broader asset reallocation among the dominant domestic and global fund buyer base.