Treasuries tack onto historic gain ahead of quarterly auctions

US Treasuries, coming off their best day so far this year on Friday, held onto most of the move to start a week featuring a heavy slate of note and bond auctions.

Yields on longer-dated bonds settled two basis points lower Monday afternoon in New York, while shorter-dated yields were little changed. Earlier, they fell to session lows on a slump in the price of crude oil.  

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Trading was choppy following a rally on Friday that sent an index of Treasuries to its biggest one-day gain since late 2023 as weak employment data stoked conviction the Federal Reserve will cut interest rates this year.

"Negative surprises like the July employment report usually move markets over many days and possibly many weeks," Morgan Stanley interest-rate strategists said in a report. They continue to recommend a long position in five-year Treasury debt, whose yield tumbled 22 basis points Friday, its biggest drop in a year.

The biggest week of Treasury note and bond sales since May could weigh on prices, though, as the US is set to auction $125 billion of new three-, 10- and 30-year debt. That helped slow momentum after Friday's surge, which was aided by persistent speculation Federal Reserve Chair Jerome Powell will be replaced by someone more willing to aggressively cut interest rates.

Investors see around 85% odds that the Fed will lower rates by a quarter point in September, based on swaps tied to policy-meeting dates. While that's down from Friday's peak of 90%, it was around 40% before the payroll data was published. 

"Markets are signaling that the Fed will have to look through any tariff-induced price rises and that a September cut is imminent," ING Groep NV strategists including Benjamin Schroeder wrote in a note. "The curve can steepen significantly more from here if that narrative strengthens."

The market ructions at the end of the week came as traders were forced out of bets on at least stable interest rates. After Wednesday's expected Fed decision to hold rates steady, they'd been cautious about betting on more cuts, especially after comments from Powell citing continued uncertainty around tariffs and inflation.

Adding to Friday's turnaround was the early exit of Fed Governor Adriana Kugler — potentially giving Trump the opportunity to appoint a low-rates loyalist instead. Trump said Powell should follow Kugler's example and resign, ratcheting up his feud with the central bank chair.

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The bond rally has turned into a payoff for some investors who had bet the gap between short- and long-dated debt would widen.

The yield premium on 30-year notes over five-year counterparts jumped 14 basis points Friday — the most since the 2023 banking crisis — to 106 basis points. It topped 108 basis points Monday before retreating to around 105 basis points.

Yields on UK and most euro-zone 10-year debt declined Monday by two to five basis points.