Bond traders ramp up bearish bets as chance of rate cut narrows

(Bloomberg) — Bond traders are betting bearish, exacerbating a sell-off in benchmark Treasuries as new evidence of strong U.S. economic growth triggers a recalibration of expectations for the Federal Reserve’s interest rate policy.

JPMorgan’s latest client survey showed that outright short positions on U.S. Treasuries rose to their highest level since the beginning of the year in the week ended April 1. That bearish sentiment spread into this week, helping to push U.S. Treasury prices higher. On Tuesday, the 10-year Treasury yield hit 4.4%, the highest level since November.

Reports released in recent days have shown strength in manufacturing and employment, bolstering claims of U.S. economic resilience that have been building throughout the year. The latest data, coupled with signs of sticky inflation and gains in commodities such as oil, prompted investors to further scale back forecasts for the timing and extent of central bank monetary easing, as well as forecasts of higher interest rates over the longer term.

Ed Al-Hussainy, rates strategist at Columbia Threadneedle Investment, said the backdrop for the Treasury market “is being affected by rising growth expectations.”

The story is similar in the Treasury futures market. As bonds fell on Monday, traders accumulated new positions across most futures varieties, pointing to a surge in short bets, according to CME Group data. Meanwhile, in options markets, data showed the cost of hedging against a sell-off in long-dated Treasuries has risen to its highest level since late February.

When it comes to Fed interest rate expectations, investors currently expect rate cuts of about 65 basis points in 2024, while the median forecast released after the Fed’s March meeting was 75 basis points. This is different from the situation in recent months. Trader forecasts at the time were more dovish than those from the central bank.

With the market so bearish, some traders are taking the opposite bet. Tuesday’s activity in U.S. Treasury options and options related to the Covered Overnight Financing Rate, which closely tracks the central bank’s key policy rate, included some sharp bullish calls. The trades are targeting a rebound in the so-called belly of the curve, around the five-year maturity area, as well as the Fed. Will cut interest rates by half a percentage point at the September policy meeting.

Here’s an overview of the latest positioning indicators for the interest rate market:

Treasury bond customers short

In the week ending April 1, JPMorgan Chase clients’ short positions increased by 7 percentage points, reaching the highest level since January 1; long positions decreased by 3 percentage points this week, and the net long position fell to the lowest level since February 1 . 20.

Hedging bond sell-off becomes more expensive

The premium paid to hedge against the sell-off in U.S. Treasuries is rising. The cost of guarding against rising long-term Treasury yields reached its highest level since late February during Tuesday’s trading session, as reflected in so-called puts/put options. Bullish bias in long-dated bond futures. In the Treasury options market, the five- and 10-year short-term volatility trades remained popular last week. Tuesday’s action saw several large bullish trades on the five- and 10-year horizons.

Deleveraging resume

The latest CFTC data for the week ending March 26 shows that asset managers and hedge funds are continuing to deleverage. The leveraged net short position in U.S. Treasury futures fell for an eighth consecutive week to the lowest level since July. Beyond the macro rate narrative, deleveraging may also reflect continued unwinding of basis trades against a backdrop of the strategy’s declining appeal. Asset managers also saw their net long positions unwound for a third consecutive week.

SOFR options are most active

The most active option over the past week was the 95.00 strike as of December 24th. Flows on Tuesday included buyers of the Sept. 24 95.00/95.25/95.50 call options targeting about 50 basis points of rate cuts already priced into the price. September policy meeting. The hot topic last week was the use of expressions such as Dec24 95.625/95.50/95.25/95.00 “output puts” to target the Fed to skip a June rate cut.

Will the Fed skip June rate cut?This is a popular play among options right now

SOFR option heat map

As of December 24, the most executed SOFR is still 95.50, with a target yield of 4.5%, where a large amount of risk can be seen in the Jun24 call option, Sep24 call option and Dec24 put option. Other top strike options include the 95.00, 95.25 and 94.875 levels, where both Jun24 calls and puts have high volumes.

——With help from Michael McKenzie.

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