(Adds Fed details, updates yields)
By Kate Duguid
NEW YORK, Feb 1 (Reuters) - January’s surge in U.S. job growth pushed yields on shorter-dated Treasury notes up on Friday morning, flattening the yield curve just days after the Federal Reserve expressed caution about further interest rate hikes this year.
The U.S. Labor Department’s closely watched nonfarm payrolls report showed employers hiring the most workers in 11 months, with no “discernible” impact on job growth from a 35-day partial government shutdown. However, the longest shutdown in history, which ended a week ago, pushed up the unemployment rate to a seven-month high of 4.0 percent.
The report came two days after the Fed signaled it may pause hiking interest rates because of softness in the economy and financial market volatility. The longevity of the U.S. economic expansion, now in its ninth year and the second longest on record, has come into question. The recent government shutdown and the ongoing trade war with China have in recent months begun to weigh on business and consumer confidence.
“If the Fed’s message on Wednesday was a dovish reaction to the data, well even in the last few days, the data has improved,” said Guy LeBas, chief fixed income strategist at Janney Montgomery Scott.
“The question for financial markets over the next few trading sessions is whether the dovish outlook from the Fed was a reaction to data inputs or whether it represents a new reaction function to the same data.”
Two-year yields, which reflect traders’ expectations of interest rate hikes, rose faster than 10-year yields. The 2-year yield was last up 2.4 basis points to 2.48 percent, with the 10-year yield up 1.5 basis points. That flattened the yield curve, measured as the spread between two- and 10-year yields to 16.2 basis points.
Following Friday’s report, traders trimmed their rate-cut bets. Contracts tied to the Fed’s policy rate had priced out any chance of a 2019 interest rate hike after Fed Chairman Jerome Powell on Wednesday said the case for rate increases had weakened. After Friday’s report, traders reduced rate-cut bets, though they continue to bet against a hike.
The CME Group’s FedWatch tool, which tracks current and past probabilities of Federal Open Market Committee (FOMC) rate changes, showed over a 95 percent chance that rates will remain unchanged through July 2019. After that, the probability falls to about 79 percent through December.
With key data from the Commerce Department, including the fourth-quarter gross domestic product report, still delayed because of the 35-day partial government shutdown, the employment report was the clearest evidence yet that the economy remains on solid ground. (Reporting by Kate Duguid Editing by David Gregorio and Jonathan Oatis)