Key Takeaways:
The 2-year Treasury yield slid to a fresh intraday low Wednesday after a weaker-than-expected ISM Manufacturing reading reinforced bets that the Federal Reserve will need to ease policy sooner than previously anticipated.
The yield on the two-year note, the most sensitive to changes in interest-rate expectations, fell as much as 8 basis points to 4.058% after the Institute for Supply Management's manufacturing index dropped to 47.8 in June from 48.7 in May, below the 49.2 consensus estimate in a Bloomberg survey. A reading below 50 signals contraction. Fed Chair Kevin Warsh, speaking shortly after the release at a conference in New York, acknowledged that "downside risks to growth have increased" and that the central bank is "closely monitoring incoming data for signs of softening," language traders interpreted as opening the door to rate cuts.
"The ISM print confirms what the regional Fed surveys have been signaling — manufacturing is decelerating faster than the consensus expected," said James Okafor, rates strategist at Edgen. "Warsh's remarks removed any doubt that the Fed is now in a data-dependent wait-and-see mode, and the bond market is pricing in a higher probability of a September cut."
The move extended a volatile stretch for short-dated Treasuries. The 2-year yield had climbed to 4.138% on Tuesday, up 0.670 percentage point year-to-date, after a string of resilient labor market readings pushed back rate-cut expectations. Wednesday's reversal erased nearly half of those gains from the prior week, when the yield touched a 52-week high of 4.230% on June 22. The 52-week low of 3.377% was set on Feb. 27.
What the ISM breakdown shows
The ISM's new orders subindex fell to 46.4 from 49.1, the lowest since February, while the production gauge dropped to 48.2 from 50.2. Employment in the manufacturing sector contracted for a third straight month, with the employment index at 47.1. Prices paid, a proxy for input costs, eased to 52.8 from 54.3, suggesting inflation pressures in the factory sector continue to moderate — a development the Fed would welcome as it assesses the trajectory of core PCE inflation, which stood at 2.6% in the latest reading.
The last time the ISM manufacturing index printed below 48 was in December 2024, when it hit 47.4. In the three months following that release, the 2-year yield fell 45 basis points as markets priced in 75 basis points of cumulative Fed cuts. The S&P 500 rose 4.2% over the same period.
Rate-cut expectations repriced
Overnight index swaps now imply a 68% probability of a quarter-point rate cut at the Fed's Sept. 16-17 meeting, up from 52% before the data release. A full 25-basis-point cut is fully priced by November, compared with December previously. The fed funds rate currently stands at 5.25% to 5.50%, where it has remained since the central bank's last hike in July 2023.
The 10-year Treasury yield fell 6 basis points to 4.32% in sympathy with the short end, while the S&P 500 trimmed earlier losses to trade 0.3% lower. The Bloomberg Dollar Spot Index slipped 0.2%, as lower rate expectations reduced the dollar's yield advantage over other major currencies.
For the Fed, the question is whether the manufacturing weakness spills over into the broader economy. The labor market has remained resilient — nonfarm payrolls averaged 218,000 over the past three months, above the 150,000 breakeven rate estimated by the Atlanta Fed. But if the ISM's employment subindex continues to deteriorate, that could change. The next test comes Friday with the June jobs report, where economists expect payrolls to have risen by 195,000.
This article is for informational purposes only and does not constitute investment advice.
