Treasuries Finish Higher

Treasuries soared amid speculation that the Fed would cut interest rates again to lift the economy

The Treasury curve narrowed on Friday as the market shifted its focus toward a less friendly outcome of Tuesday's FOMC and away from stocks (at least temporarily). Changing Fed policy expectations was a dominant influence in the market all week, and especially Friday.

Reassessment of the view that the FOMC could cut rates as soon as Tuesday helped the spread on the two-year note and 30-year bond spread to shrink back to the +300 basis points area from over +330 basis points at the height of rate cut frenzy earlier in the week. After pricing in about 52% chance of an August 13 rate cut, traders decided to take some chips off the table, with the futures market now showing only about 5% probability.

Interestingly, the market's re-pricing came on the same day that a major U.S. investment bank made the headlines by forecasting a 50 basis points rate cut on Tuesday. The long end was also boosted by convexity trades (and front-running of such), as well as friendly Q2 nonfarm productivity data. Productivity rose 1.1%, about double what was expected, while unit labor cost rose a tamer-than-expected 2.4%.

Stop loss buying also contributed to upide momentum as the rally took many traders by surprise. For a change, Treasuries didn't trade in lock-step with stocks.

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