(Bloomberg) -- Traders in the US interest-rates market have started to put on wagers that the Federal Reserve will refrain from cutting borrowing costs this year.
With the economy proving resilient and progress on inflation having stalled, policymakers of late have been signaling that they expect to keep rates higher for longer. That's had ripple effects across hedging instruments.
Ahead of the May 1 Fed decision, traders have built positions in options linked to the Secured Overnight Financing Rate — which closely tracks the central bank's benchmark — targeting a scenario where officials keep rates steady past December's policy meeting. Some of the more aggressive bets have also hedged the possibility that the central bank will even deliver another hike in 2024.
Either way, that's more hawkish than the consensus priced into swaps, which show a total of roughly 40 basis points of cuts by year-end, meaning the better part of two quarter-point reductions. That faith in an eventual pivot to easing helps explain the solid demand for Tuesday's record $69 billion two-year Treasury auction.
Still, some traders are bracing for the possibility of a deeper slump in Treasuries, after a selloff sent yields on various maturities to their 2024 highs this month.
Tuesday's standout flow in Treasury options was an $11 million wager targeting 10-year yields to rise through 5% within a month, compared with about 4.6% now. And in the cash market, JPMorgan Chase & Co.'s latest client survey showed neutral positioning was the largest in two months.
Meanwhile, hotter-than-projected inflation data is roiling futures positioning as well. Asset managers have shifted to record net longs in 2- and 5-year note futures, Commodity Futures Trading Commission data suggests. The change probably reflects a move to exit short positions as yields surged, according to a Bank of America Corp. analysis.
Here's a rundown of the latest positioning indicators across the rates market:
Historic Futures Shift
While asset managers' net long positions in 2- and 5-year note futures pushed to record levels, it did appear that hedge funds took a portion of the other side. That group extended their duration short by a net amount of 307,000 10-year note futures equivalents, CFTC data through April 16 shows. Most of the action was also seen in 2- and 5-year note tenors, where leveraged funds now have record shorts.
The overall bullish duration shift among asset managers across the curve was equivalent to roughly 740,000 10-year note futures equivalents, the most in at least seven years. The CFTC data reflects weekly reporting which captured events including data on consumer and producer prices.
Treasury Clients Longs Drop, Shorts Rise
JPMorgan's latest survey showed longs dropping four percentage points, while shorts and neutrals rose two percentage points. Changes were minimal over the week as cash investors wrestled with haven demand and strong US economic data. Neutral positioning among clients has now risen to the biggest since Feb.
SOFR Traders Target Higher Policy Rates
Strikes with the most risk added over the past week include the 94.375 which featured in hawkish positioning such as the SFRZ4 94.50/94.375/94.125/94.00 put condor. That targeted a year-end yield of roughly 5.625% to 5.875% and above the current 5.33% fed effective rate.
It hasn't all been one-way, however, with the most risk added in 96.00 and 97.00 strikes following flows over the past week in the Dec24 96.00/97.00 call spread, which targets an aggressive path of Fed rate cuts by the end of the year.
SOFR Options Heat Map
The most-crowded SOFR options strike out to the Dec24 tenor is the 95.00 level, equivalent to a 5% rate, where heavy amounts of open interest remains in the Jun24 calls. Large amounts of open interest were also seen in the Jun24 calls on the 95.50 strike, the second-most populated. Across other options, there remains a decent amount of open interest in Jun24 puts across the 94.75, 94.875 and 94.9375 strikes.
Premium Remains to Hedge Long-End Selloff
While it's gotten a bit cheaper than recent elevated levels, the cost of hedging a selloff in the long end of the curve remains expensive compared to the price for the front- and belly. Recent flows in the options market have been skewed toward a bigger selloff in Treasuries, starting with Tuesday's $11 million wager targeting 10-year yields as high as roughly 5.05%. In the long-end, flows last week included a buyer of long-bond puts targeting 30-year yields rising to 4.9% by the end of this week. They were last around 4.73%.
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