(Bloomberg) — Traders are rapidly unwinding bets for a rally in US Treasuries ahead of Wednesday’s rare double-risk event, with the release of inflation data coming just hours before a Federal Reserve interest-rate decision.
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The likelihood that US policymakers will keep borrowing costs higher for longer is overtaking optimism surrounding the dawn of the Fed’s easing cycle, according to futures positioning data underlying the $27 trillion Treasury market.
It’s a shift that has gained momentum in the days since surprise strength in the labor market jolted traders who’d been girding for a bond rally and the potential for multiple rate reductions in 2024. Open interest has dropped around 80,000 contracts in 10-year note futures since Friday’s jobs data, signaling that traders are unwinding their bullish bets.
Now, investors are fully pricing in just a single cut this year ahead of inflation data that stands to reset trader expectations just hours before the Fed unveils its rate decision. An update of the Fed’s quarterly economic and interest rate projections — known as the dot plot — will then provide yet another piece of information that could whipsaw markets.
“We’re less willing to go into this meeting with big bets in either direction,” said Nathan Thooft, global chief investment officer for multi-asset solutions and senior portfolio manager at Manulife Investment Management. “The sizing of our bets in general have come down this year, mainly because of the uncertainty of when and how much the Fed will do.”
Momentum behind higher-for-longer interest rates is also evident in the cash Treasury market. A JPMorgan Chase & Co. Treasury client survey on Tuesday showed the net-long position among investors dropped to the lowest in two months. And yields on 10-year notes have have climbed as high as near 4.48% earlier this week from as low as 4.27% before Friday’s jobs report, with traders sharply paring back wagers on gains in 10-year note futures.
The pullback in bullish bets after the US employment figures leaves a “structurally neutral” positioning setup in US Treasuries, “a function of the tension between above-target inflation and moderating growth,” Citigroup Inc. strategist Ed Acton wrote in a note, referencing the bank’s positioning model.
Vanguard Group Inc., the roughly $9 trillion fund giant, is being “very tactical” in terms of positioning, said John Madziyire, senior portfolio manager, adding that “we’ve lightened up our positions” before the CPI data and Fed meeting. The Treasury market remains in a broadly defined yield range, with “every data print being a high vol event” for traders, Madziyire said.
To Key Wealth’s Rajeev Sharma, market participants — and data-dependent Fed officials — are waiting for clear signs of ebbing price pressures before they again bet again on lower interest rates.
“The narrative we need to see is inflation sustainably comes down,” said Sharma, managing director of fixed Income at Key Wealth, which oversees $51 billion in assets. “It’s very likely that the dot plot will bring the rate cuts down to two, but I won’t rule out the possibility of no rate cut in 2024. I don’t believe the Fed is any hurry to cut rates.”
In the options market linked to the Secured Overnight Financing Rate, traders in recent weeks have even embraced bets on elevated policy rates tat stretch into late next year and early 2026. These positions stand to benefit from a hawkish shift to the policymakers’ dot-plot forecast, should their outlook for rate cuts diminish.
Here’s a rundown of the latest positioning indicators across the rates market:
Unwinding Cash Longs
In the week up to June 10, JPMorgan Treasury clients unwound long positions by 7 percentage points, shifting to a neutral stance and dropping the net long positioning to the lowest since April 8. Outright short positions were unchanged over the week.
SOFR Options Heatmap
The most populated SOFR options strike remains the 94.875 level, which features outstanding trades such as the SFRU4 94.875/94.8125/94.75 put fly and the SFRU4 94.8125/94.875/94.9375/95.00 call condor. The 94.625 strike also remains heavily populated with positioning around the level, including the SOFR Sep24/Dec24 94.875/94.625 put spread/spread.
Options Premium Back to Neutral
A week after the cost of hedging a bond market rally rose to the highest since February, the options skew pushed back closer to a neutral stance, a further indication that investors are shifting away from recent bullishness. Recent flows in 10-year options however have included continued demand for upside protection at lower prices. Monday’s session saw the familiar July 10-year 111.00 calls bought at a level of 5 ticks for new risk, compared to previously 19 ticks for bigger sizes. Open interest in the strike has risen above 100,000 options, targeting a 10-year yield drop to roughly 4.18%.
Asset Manager Duration Longs Unwound
For the second week in a row, asset managers pared bullish Treasury futures wagers after CFTC data in the week up to June 4 showed an equivalent duration unwind of roughly 40,000 10-year note futures equivalents. Prior to this, asset managers had been extending long positions over several consecutive weeks from April 16 through to May 21. On the flip side, hedge funds extended their net duration shorts by roughly 168,000 10-year note futures equivalents, pushing overall net duration shorts through 7 million contracts.
Active SOFR Options
Recent activity across SOFR options has seen open interest rise substantially across strikes used within the SOFR Sep24 94.8125/94.75/94.625 put tree, boosting positioning in these strikes. Positioning in the 95.00 strike has also seen a boost over the past week, with flows including buyers of the Sep24 95.00/95.75/96.50 call fly, targeting a faster pace of Fed cuts.
–With assistance from Ye Xie, Carter Johnson and Michael Mackenzie.
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