(Bloomberg) -- Bond traders are unwinding a flurry of recent wagers against US Treasuries as confidence returns that the Federal Reserve will be able to cut interest rates again this year.
As war in the Middle East sent oil prices soaring, stoking inflation fears, traders pushed back expectations for the Fed's next rate cut into next year. This week, the market shifted back to pricing at least one quarter-point reduction by the end of 2026.
The moves suggest that the $31 trillion bond market is starting to weigh the potential risks to growth, as well as the inflation threat. That shift has also helped underpin a recovery in US Treasuries, with the two-year yield sliding about 10 basis points since a peak of 3.76% last week.
"The rates market has seen a fast and furious repricing," said Ruben Hovhannisyan, generalist portfolio manager at TCW, said in an interview. While a lasting war could shift the inflation outlook, "our base case is that it will probably resolve in a matter of weeks, but not months.
"You will have a bump in CPI, but the pass-through to core inflation will be generally small," Hovhannisyan said, adding that a weak labor market could dull the impact.
While no change is expected at Wednesday's Federal Reserve's meeting, policymakers will set projections on the rates path in coming months.
Traders will also scrutinize Chair Jerome Powell's press conference for the central bank's views on higher energy prices against signs of a softening labor market. Oil won some respite earlier as Iraq signed a deal to resume exports via Turkey that avoid the Strait of Hormuz.
'Exaggerated'
The sharp selloff in US rates was likely exaggerated by several factors beyond economic fundamentals, RBC strategists Blake Gwinn and Izaac Brook wrote in a note, including "positioning pain and deleveraging."
That was followed by profit taking in hawkish hedges and unwinding of SOFR option positions, which are tied to the Secured Overnight Financing Rate. One position across SOFR put options placed in January, before the war started, generated a $10 million profit as short-end yields climbed over the past couple of weeks. On Monday, more such hedges placed via put options appeared to be liquidated.
"Open interest and price moves suggest the futures market likely saw even larger position adjustments," Morgan Stanley strategists including Shaun Zhou said in a note, comparing the unwinds in the futures market to those seen in swaptions. After the wave of unwinds, "remaining exposure to a continued selloff in front-end rates looks much cleaner."
In the cash market, a Tuesday release of JPMorgan Treasury client survey showed that neutral positioning remains elevated. Meanwhile, Citadel Securities has dropped its bearish stance toward US Treasuries this week, shifting to a neutral view on US government debt.
Here's a rundown of the latest positioning indicators across the rates market:
JPMorgan Client Survey
In the week to March 16, JPMorgan clients' long positions rose two percentage points with shorts unchanged. The survey shows the most amount of outright longs since Dec. 15, while neutral positions remain elevated.
SOFR Options
Over the past week, there has been a huge position add around the 96.4375 strike fueled by open interest gains mostly across Jun26 calls and puts. Flows have included buying of the SFRM6 96.4375/96.50 call spread vs selling 2QM6 97.375 calls. Popular plays recently have also included SFRM6 96.4375/96.5625 call spreads and SFRM6 96.4375/96.5625/96.6875 call flies. Popular positioning has also been seen over the past week around the 96.625 strike due to large open interest gains in the Dec26 puts where flows have included buyers of SFRZ6 97.00/96.625 1x2 put spreads.
Broadly, the most heavily populated strike across Jun26, Sep26 and Dec26 options is currently the 96.50 level, followed by the 96.4375 mostly due to continued buying of the SFRM6 96.4375/96.50 call spreads vs selling 2QM6 97.375 calls where positioning in the ratio bull steepener structure is up to around 100k vs 50k. There also remains a heavy amount of open interest in Sep26 calls in the 96.75 and 97.00 strikes.
Treasury Options Premium
The premium paid to hedge futures risk in Treasuries has bounced off multi-month extremes, but remains heavily favoring premium for puts, especially in the long-bond futures contracts. The partial retracement has occurred mostly during Monday's session, which saw some relative calmness restored to the Treasuries curve which also saw long-end swap spreads aggressively wider on the day.
--With assistance from Carter Johnson.
(Adds Wednesday's prices.)
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