ISM Manufacturing Data to Test Bond Market's 4.47% Yield Wagers

The May ISM Manufacturing Index arrives Monday as bond traders weigh whether a resilient economy will force the Federal Reserve to reverse course and hike rates by mid-2027.

The US manufacturing sector faces a key test Monday as the May ISM Manufacturing Index lands at 10 a.m. Washington time, with bond traders pricing a 50% chance the Fed delivers a rate hike by mid-2027.

"Yields have risen, and it's adding restrictiveness to the US economy and doing the work of the Fed," said George Catrambone, head of fixed income at DWS Americas.

The 10-year Treasury yield stood at 4.47% Monday, up three basis points, as oil prices rebounded from a six-week low. The two-year yield, more sensitive to Fed expectations, traded near 4% — about 60 basis points above late February levels. The jump has brought short-term yields closer to longer-dated debt, flattening the curve as traders reassess the rate path.

A reading above the 50 expansion threshold would reinforce the narrative that the economy is running too hot for the Fed to ease, potentially pushing yields toward 5% — a level not seen since 2023. A miss below 50, by contrast, would fuel recession fears and strengthen the case for cuts, giving the bond market ammunition to push back against the hawkish repricing.

The ISM release kicks off a data-heavy week culminating in Friday's May employment report, which economists expect to show 90,000 jobs added and the unemployment rate steady at 4.3%. Combined with last week's data showing the Fed's preferred inflation gauge — the personal consumption expenditures price index — rose 3.8% annually in April, the numbers will shape expectations for the central bank's June 17-18 meeting, the first under Chairman Kevin Warsh.

The Cross-Asset Transmission Chain

A strong ISM reading would likely boost the dollar and pressure rate-sensitive sectors of the equity market, particularly real estate and utilities, which have already lost ground this year as yields climbed. The S&P 500's financial sector, which benefits from a steeper yield curve, could gain if the data signals the economy can withstand higher rates.

The jump in bond yields since the Iran conflict began has already tightened financial conditions by the equivalent of about three-quarters of a percentage point of Fed rate increases, according to Bloomberg Economics. That tightening is doing some of the central bank's work, but it also risks slowing the economy more than intended if sustained.

What Comes Next

"If the inflation numbers stay high and job growth remains solid, then the market could start to price in a more aggressive shift higher in rates from the Fed," said Gregory Faranello, head of US rates trading and strategy for AmeriVet Securities. "One hike will not do anything here."

Traders see a hike by mid-2027, if not sooner, as the spike in energy prices has upended expectations that Warsh would deliver cuts soon after taking over. The May ISM data will either validate that view or force a recalibration. The last time the ISM Manufacturing Index exceeded 50 for three consecutive months was in late 2023, preceding a period where the 10-year yield fell more than 100 basis points as the market priced in rate cuts.

This article is for informational purposes only and does not constitute investment advice.