(Bloomberg) -- A disappointing report on activity in the largest swathe of the U.S. economy drove heavy buying in Treasuries on Thursday, as investors added to wagers on more action from the Federal Reserve to avert a recession.
This latest evidence that domestic growth is struggling has boosted positioning for rate cuts at the Fed’s two remaining meetings this year. A half-point of additional cuts is now closer to being fully priced into futures contracts. Government bonds rallied on a survey showing unexpected weakness in the services sector, including a slide in the forward-looking new orders component and retrenchment in employment.
The two-year yield dropped as much as 11 basis points to 1.37% and the 10-year was down 8 basis points at 1.52%, though both have since risen slightly. Buying in the shorter-maturity notes -- which are more sensitive to interest rate policy -- outpaced trade in the long end. That pushed the gap between two- and 10-year yields to its widest point of the session, around 16 basis points, the steepest since early August.
Gene Tannuzzo at Columbia Threadneedle Investments now sees a higher likelihood of an economic downturn in the next year, putting the odds at more than 50%. The portfolio manager is looking for a cut at both of the remaining Fed meetings this year, and he’s expecting the curve to steepen further.He’s also looking for slowing growth to become more evident in non-farm payrolls data, which is due Friday.
“I think if you look through the details, we’ve been decelerating for about a year,” he said.
This week, traders were already adding to positions for more Fed easing, as a report showing U.S. manufacturing sinking further into contraction deepened their concerns for the nation’s growth outlook. The softening in services sector activity, which accounts for a far larger chunk of U.S. economic output, adds to worries that the world’s largest economy may be headed for recession.
Fed funds futures indicate traders expect roughly 42 basis points of cuts by the end of 2019, and almost a full percentage point by the end of next year.
Thursday’s report also sank inflation expectations even further. The measure reflecting the market’s outlook for the consumer price index’s path over the next decade -- the 10-year breakeven -- fell to 1.48%. That’s the lowest since September 2016, and shows investors losing faith in the Fed’s ability to fulfill its mandate to keep inflation around the 2% target.
(Updates prices with comment)