Traders bet on post-war calm to keep rates in tight range

(Bloomberg) -- Traders are building up bets that bond market volatility will keep falling, even as a US-Iran peace agreement remains elusive.

After a key measure of US Treasuries volatility fell to pre-war levels, traders continued to place large wagers that stand to benefit from a prolonged period of stability that will keep Treasury yields in a narrow range in coming weeks.

So far this month, US 10-year yields have traded within a range of just 16 basis points as a two-week ceasefire between the US and Iran — originally set to expire Wednesday — helped bring oil prices down from multi-year highs. The rise in popularity of short-volatility strategies is also apparent in the increased demand for short positions in structures of so-called straddles and strangles in US 10-year notes.

The trend has analysts at JPMorgan Chase & Co. warning that the decline in volatility may be overdone. In a note Friday, they cited "continued two-sided risks to both inflation and the job market, in addition to the risks to the ceasefire" and the nomination hearing of Federal Reserve Chair nominee Kevin Warsh, which kicked off Tuesday.

In a sign of how quickly bets on calmer markets could unwind, bond market volatility as shown in swaptions edged higher on Tuesday after the New York Times reported that Vice President JD Vance delayed his trip to Pakistan amid a hold in US-Iran peace talks. President Donald Trump said later that he was extending the ceasefire until talks concluded.

While oil prices rose back above $100 a barrel on Wednesday, Treasury yields held their ground. The 10-year yield was little changed at 4.29%.

The volatility trades also benefit from expectations that the Fed will keep its policy rate unchanged in coming months. In testimony Tuesday, Warsh avoided answering questions about the near-term path of interest rates, further supporting the market's wait-and-see stance.

"The Fed is on hold, and rates are probably range bound," Shiyan Cao, a portfolio manager at hedge fund Winshore Capital Partners LP. "So volatility should be lower, assuming the war is over in the next few days."

Most of the trades have been centered around June 10-year options that expire in about a month, with the standout being a $7.3 million premium position.

In over-the-counter derivatives — which reflect financial contracts negotiated directly between two parties rather than through an exchange — a short volatility stance has continued to emerge as traders have targeted so-called receiver-based structures which look to target additional policy easing from the Fed.

"Flows suggest that investors have been selling vol across the surface, with the overall short vol bias near the extreme levels of January," Barclays strategists Amrut Nashikkar and Eveline Dong wrote in a note.

In the Treasuries cash market over the past week, investors have appeared as more bullish, according to a survey of JPMorgan clients for the week up to April 20, where net long positioning now sits at most elevated in three weeks.

Here's a rundown of the latest positioning indicators across the rates market:

JPMorgan Treasury Client Survey

In the week up to April 20, short positions were reduced by four percentage points while long positions and neutrals rose two percentage points. The net effect has left clients most long since March 30.

SOFR Options Positioning

Across SOFR Jun26, Sep26 and Dec26 options there was a large amount of new risk added in 96.8125 strikes following flows over the past week including SFRU6 96.50/96.8125/97.125 call flies bought outright and vs. SFRU6 96.00/95.75 put spreads as a risk reversal position. Additional flows around the strike have included SFRM6 96.50/96.6875/96.8125 1x3x2 call flies and SFRZ6 96.625/96.8125/97.00 call flies. Flows have also been plentiful around the 96.5625 strike, including buyer of SFRM6 96.4375/96.5625 call spreads and SFRM6 96.5625/96.4375/96.375 1x3x2 ratio put flies.

The 96.50 strike remains the most populated in options across Jun26, Sep26 and Dec26 tenors, where large amounts of open interest can be found in Jun26 calls and puts, along with Dec26 calls. June SOFR options expire June 12 and a week ahead of the June 17 policy announcement. The 96.75 strike is also well populated in Sep26 calls, where recent flows have included buyer of the SFRU6 96.4375/96.5625/96.625/96.75 call condors.

Treasury Options Skew

The premium paid to hedge options in the front end of the curve has trended back toward neutral, after favoring puts toward the start of the month. In the long end, premium remains skewed toward puts — as traders pay to hedge a bond selloff versus a rally — but is less elevated compared with the start of the month. Premium in 5- and 10-year tenors continues to trend back toward neutral.

--With assistance from Ye Xie.

(Adds US Treasuries pricing in paragraph six.)

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