The Payrolls Paradox: How Weak Employment Data May Still Support a Treasury Rally in 2026

The U.S. labor market has shown signs of weakening in late 2025, with rising unemployment and stagnant job growth. Yet, despite these indicators, Treasury yields remain elevated. This apparent contradiction-where weak employment data coexists with a lackluster bond market response-raises a critical question for investors: Can a Treasury rally still materialize in 2026, even as labor market fundamentals deteriorate? The answer lies in the interplay between market expectations and the lagged effects of monetary policy, a dynamic that has historically driven bond prices higher in the face of economic uncertainty.

Labor Market Realities: A Mixed Picture

According to the Bureau of Labor Statistics, total nonfarm payroll employment in November 2025 rose by just 64,000 jobs, with little net change since April 2025. The unemployment rate edged higher to 4.6%, while the broader U-6 measure, which includes part-time workers and those not actively seeking employment, stood at 8% in September. These figures suggest a labor market that, while not in freefall, is losing momentum. Meanwhile, job openings remain elevated at 7.67 million, indicating structural imbalances between supply and demand.

The Federal Reserve's September 2025 Summary of Economic Projections anticipated a median unemployment rate of 4.4% in 2026, a forecast echoed by the Survey of Professional Forecasters. However, recent data has raised concerns about a sharper rise in unemployment, including a net decline in October jobs and a weak private-sector payroll increase of 41,000 in December (below the 50,000 estimate).

Market Expectations: Rate Cuts and Yield Projections

Despite these labor market headwinds, Treasury yields have remained stubbornly high. The December 2025 Fed Dot Plot projects a gradual easing to 3.375% by year-end 2026, implying only one 25-basis-point rate cut. Analysts at LPL Research argue that 10-year Treasury yields will likely hover between 3.75% and 4.25% in 2026, driven by inflation above the 2% target and increased bond supply from government and corporate issuers. This suggests that markets are pricing in a cautious Fed, prioritizing inflation control over aggressive rate cuts.

However, historical patterns reveal a different story. Weak payrolls data has repeatedly triggered Treasury rallies as investors anticipate accommodative monetary policy. For instance, a December 2025 private-sector payroll increase of 41,000-below expectations-prompted a drop in 10-year yields to 4.12%, reflecting heightened demand for safe-haven assets. Similarly, a net decline in October jobs led to a yield retreat to 4.168%, underscoring the inverse relationship between labor weakness and bond prices.

The Payrolls Paradox: Mechanisms at Play

The disconnect between labor market data and Treasury yields can be explained by three key mechanisms:
1. Inflation Expectations: Weaker employment data often signals slowing consumer spending, which can temper inflation. This reduces the urgency for the Fed to maintain restrictive rates, creating a tailwind for bond prices.
2. Investor Sentiment: Markets frequently overreact to near-term data, pricing in extreme scenarios. A weak payrolls report can trigger a flight to quality, with investors shifting capital into Treasuries despite broader economic uncertainty.
3. Policy Lags: Central bank actions take time to materialize. A delayed September 2025 jobs report, which showed stronger job creation but a higher unemployment rate, led to a drop in yields as investors priced in potential rate cuts. This highlights how policy expectations, rather than current data, often drive bond market moves.

Implications for 2026

While the Fed's rate-cut trajectory appears constrained, the labor market's fragility could force a reevaluation. If unemployment rises further-say, to 4.5% or higher in early 2026- as projected by the Survey of Professional Forecasters, the case for aggressive easing will strengthen. This could trigger a Treasury rally, even if yields remain above historical averages. Investors should also monitor Japan's rising yields and the anticipated shift in Fed leadership, both of which could amplify volatility.

In conclusion, the "payrolls paradox" underscores the importance of distinguishing between market expectations and economic realities. While current data suggests a fragile labor market, the bond market's response will ultimately hinge on how quickly the Fed pivots to accommodate these trends. For now, the stage is set for a potential Treasury rally-one that could surprise even the most seasoned observers.