(Bloomberg) -- Bond investors are on alert for any signs of US economic weakness in Friday’s employment report, as they assess whether the recent rally in Treasuries has further room to run.

US bonds are headed toward their first weekly loss in almost two months before a key reading of labor data, which will offer clues as to whether President Donald Trump’s trade war and efforts to reduce government headcount are hitting jobs and making a case for the Federal Reserve to resume interest-rate cuts.

It’s a key test for the Treasuries market, which has already risen 2.2% this year as traders boosted their bets that a slowing economy — and uncertainty around the policies coming out of Washington — will force the Fed to ease monetary policy again. The Fed last lowered rates in December.

“The economy is obviously slowing,” said Gang Hu, managing partner at Winshore Capital Partners. “If the payroll comes out on the weak side, markets will bet that the Fed will cut rates in May. There’s still room for yields to go down.”

Traders see a roughly 50% chance that Fed officials will lower rates by a quarter point when they meet in May, though the first fully priced-in move isn’t until June. In all, they expect about 73 basis points worth of easing — or a little less than three rate reductions — in the remainder of 2025.

Rally Overdone?

The prospect of further cuts in the near-term would give bullish investors a boost after concern in recent days that the rally in bonds is overdone.

Strategists at JPMorgan Chase & Co have recommended clients go short two-year notes, in part because of “stretched” bullish positions. And in the options markets, some traders who’d been targeting a further rally — and even a 10-year yield below 4% — have begun to unwind their wagers and take profit.

Two-year yields, which are most sensitive to Fed policy, hit a five-month low of 3.84% this week before rebounding. The short-dated note yielded 3.94% as of 7:30 a.m. in New York, while 10-year rates were at 4.25%.

“If the job market shows material weakness, people will get much more worried about recession risks. I think that the risks are asymmetric – so a bigger reaction if we get a weak number,” said Priya Misra, portfolio manager at JPMorgan Asset Management. Misra is neutral on the Treasury market now after being long earlier this year.

DOGE Impact

Economists surveyed by Bloomberg expect the February employment report to show a pickup in payroll growth, with the unemployment rate steady at 4%.

But some flag the risk that the government job cuts led by Elon Musk’s Department of Government Efficiency, or DOGE, will start trickling out into the broader economy. Bloomberg Economics estimates that tens of thousands of federal jobs have been cut in the weeks since President Donald Trump took office.

“The markets have shifted from being solely focused on inflation to now being much more concerned about downside risk in growth,” said Michael Cloherty, head of US rates strategy at UBS Securities.

He added that the bond rally is “a little bit” overdone and the market may be stabilizing. “There’s a big difference between a slowdown and real severe economic stress,” he added.

--With assistance from Edward Bolingbroke.

(Updates yield levels.)