The unexpectedly strong U.S. non-farm employment report released last Friday suggests that the U.S. economy may not be slowing down as expected, bringing the "no landing" scenario back into focus for the bond market.

The "no landing" scenario refers to a situation where the U.S. economy continues to grow and inflation heats up again, leaving the Federal Reserve with little room to cut interest rates.

This scenario had been largely ignored by the bond market in recent months, as traders had anticipated a slowdown in U.S. economic growth and moderate inflation, leading the Federal Reserve to make significant interest rate cuts. As a result, they heavily invested in short-term U.S. Treasury bonds that are sensitive to changes in Federal Reserve interest rates.

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However, the unexpectedly strong September non-farm employment report has raised concerns about economic overheating, dampening the buying frenzy for U.S. Treasury bonds and causing U.S. Treasury yields to soar from multi-year lows. On Monday, before the U.S. stock market opened, the yield on the 10-year U.S. Treasury note returned to 4%, and the yield on the 2-year U.S. Treasury note broke through 4% for the first time since August.

Expectations for interest rate cuts have significantly diminished.

Investors have started to reduce their bets on interest rate cuts in November, with the market now pricing in a 24 basis point cut at the November Federal Reserve meeting, and a 25 basis point cut is no longer a foregone conclusion. By October 2025, the market expects a total of 150 basis points in interest rate cuts, down from the 200 basis points expected at the end of September.

At the same time, behind the wage growth lies the risk of inflation, and the potential for oil price surges due to conflicts in the Middle East have also reignited inflation concerns. The 10-year breakeven inflation rate (a measure of bond traders' inflation expectations) has reached a two-month high, rebounding from a three-year low in mid-September. This data precedes the PCE inflation data that will be released this week.

George Catrambone, Head of Fixed Income for the Americas at DWS, said:"Due to the anticipated reduction in the magnitude of interest rate cuts, the rise in short-term interest rates has been a pain point for trading. He noted that the possible scenarios are that the Federal Reserve either stops cutting rates altogether or is forced to raise rates again."

"No Landing" expectations are heating up.

Previously, market discussions have mainly focused on whether the economy can achieve a "soft landing" or a "hard landing." The strong performance of the September non-farm employment report led some to believe that the Federal Reserve's decision to cut interest rates was inappropriate, especially when the U.S. stock market is at an all-time high, the economy is expanding at a solid pace, and inflation has not yet fallen to the Federal Reserve's target.

Some renowned investors and economists, including Stanley Druckenmiller and Mohamed El-Erian, warned that the Federal Reserve should not be bound by market expectations for rate cuts or its own expectations. El-Erian warned that "inflation has not subsided."

Former Treasury Secretary Larry Summers believes that the Federal Reserve needs to consider the risks of a "no landing" and a "hard landing," considering last month's significant rate cut a "mistake."

There are also those who believe that the Federal Reserve's significant rate cut last month, coupled with China's unexpected stimulus measures, has made the market less worried about economic growth issues. Tracy Chen, portfolio manager at Brandywine Global, believes:

"A 50 basis point rate cut should no longer be on the table, as the Federal Reserve's easing policies and China's stimulus measures have increased the likelihood of a 'no landing' scenario."

Bloomberg strategist Alyce Andres also pointed out:"Last Friday's rise in yields was due to investors rushing to lock in current rates before the anticipated increase in interest rates. Given signs of inflation, a stable labor market, and a strong economic momentum, the market may be heading directly for a 'no landing' scenario rather than a soft landing."

Some investors also believe that the latest employment data is not sufficient to change the necessity for the Federal Reserve to adhere to its accommodative policy path, using the selling opportunity to buy Treasury bonds. Jamie Patton, Co-Chief Investment Officer of Global Rates at TCW, said:

"The latest employment data is not enough to change the necessity for the Federal Reserve to adhere to its accommodative policy path, as the overall data, including a decline in the quit rate and an increase in auto loan and credit card delinquency rates, indicates a softening labor market and an economy facing downward risks. A single data point cannot change our macro view of the overall weakening labor market."

Patton stated that she took advantage of Friday's selling opportunity to purchase more two-year and five-year Treasury bonds, increasing her steepening positions on the yield curve. She believes that rekindled inflation concerns may prevent the Federal Reserve from cutting rates, but this will increase the risk of the Federal Reserve maintaining borrowing costs at too high a level for too long, potentially leading to a more severe economic recession.

The market is closely watching this week's CPI report, with expectations that the core CPI will decrease from a 0.3% month-over-month increase in September to 0.2%. Current market pricing indicates that a soft landing scenario remains the base forecast for investors. The 10-year breakeven inflation rate is at 2.2%, still broadly in line with the Federal Reserve's 2% inflation target. The swap market shows that traders expect the Federal Reserve to end its accommodative cycle around 2027 with rates around 2.9%, in line with the widely accepted neutral level.