(Bloomberg) -- Bond traders have shifted to wagering on losses in Treasuries, aggressively dumping bullish futures positions after the Mideast conflict triggered a surge in oil prices and sparked inflationary worries.
The swing in sentiment, following a big February rally in US government debt, came last week as yields soared along with crude in response to the broadening hostilities. Traders have also pared the amount of Federal Reserve policy easing they expect this year ahead of Wednesday data that's projected to show inflation remained well above the central bank's target even before the fighting erupted.
Open interest, the amount of risk held by futures traders, shrank across maturities last week, from five-year Treasury notes out to the long-end. On the first trading day after the outbreak of fighting, overall futures risk dwindled by almost $17 million per basis point across the curve, equivalent to roughly 250,000 10-year futures contracts.
This month's slump in Treasuries "is really a deleveraging dynamic," with traders liquidating long positions as they price in fewer Fed cuts and the risk of hotter inflation, said David Bieber, a strategist at Citigroup Inc. The result is that the futures market has flipped to a tactical short stance for now, he said.
The Treasury yield curve steepened modestly on Wednesday, with the two-year yield little-changed at 3.59% and the 10-year yield one basis point higher at 4.17%.
Monday's trading showed how the newly bearish tilt is leaving Treasuries vulnerable to sharp bouts of short covering and volatility. Bonds got a boost late in the day, pushing yields and oil lower, after President Donald Trump told CBS that the Iran war is "very complete, pretty much."
The selling then resumed Tuesday as a wave of corporate debt issuance weighed on fixed income broadly. Benchmark 10-year Treasury yields are up about 20 basis points since Feb. 27, the day before the US and Israel launched their attack on Iran, with most of the move coming last week.
The broad move to a short position comes before Wednesday's release of February's consumer-price index. It's forecast to show a year-on-year increase of 2.5% for the core reading, unchanged from January. The Fed targets an annual inflation rate of 2%.
Investors may shrug off a benign figure "as stale information" that doesn't reflect the inflationary risks that have emerged in the past week, Ian Lyngen, head of US rates strategy at BMO Capital Markets, wrote in a report Tuesday.
"However, if core-CPI unexpectedly comes in stronger, the market's inflationary jitters will be exacerbated, pushing Treasury yields higher as rate-cut expectations are trimmed," he wrote.
In the cash market as well, investors are signaling wariness around the potential for higher yields. A JPMorgan Chase & Co. client survey released Tuesday showed short positions rising to the highest level in three weeks.
Here's a rundown of the latest positioning indicators across the rates market:
JPMorgan Client Survey
In the week to March 9, JPMorgan clients increased outright short positions by 4 percentage points, the largest one-week jump since Jan. 12, to the most short in three weeks. Longs rose 2 percentage points with neutrals dropping 6 percentage points.
SOFR Options
Over the past week, the 96.4375 strike saw a large amount of action with notable new risk seen in both Jun26 calls and puts. Standout flows included buyer of the SFRM6 96.4375/96.5625 call spreads and SFRM6 96.4375/96.5625/96.6875 call flies. For downside, there's been demand for SFRM6 96.50/96.4375/96.375/96.3125 put condors in decent size. There has also been heavy risk addition in the 96.875 strike via Sep26 calls, with recent flows including buyer of SFRU6 96.50/96.875/97.25 call flies.
Broadly, the most heavily populated strike across Mar26, Jun26 and Sep26 options is currently the 96.4375, given the large position additions seen in Jun26 calls and puts over the past week. Ahead of the SOFR March options expiry on Friday, there remains a lot of outstanding open interest in calls around 96.4375, 96.375, 96.50 and 96.625 strikes. For puts, large amounts of open interest remains in the 96.375 and 96.3125 strikes.
Treasury Options Premium
The premium paid to hedge futures risk in Treasuries has moved sharply to favor puts over calls in the past week in the long-end of the curve, where long-bond skew has dropped to levels last seen in January. On Monday, 30-year yields peaked at 4.83%, the highest in about a month. The skew in the front-end out to the 10-year sector remains slightly in favor of calls over puts.
--With assistance from Michael MacKenzie.
(Adds Treasuries pricing in paragraph five.)
More stories like this are available on bloomberg.com
