by Edward Bolingbroke
Bond traders are starting to hedge for a possible economic slowdown by placing wagers on a big market rally after weeks of just sitting tight and staying neutral.
Treasuries have surged this past week, sending yields sliding to year-to-date lows Tuesday — the 10-year dropped to 4.28% from as high as 4.57% under a week ago. Option traders are shifting their positions as the US economy, which is already showing signs of weakness, faces more pressure under Donald Trump’s tariffs.
While US bond yields edged two basis points higher to 4.31% on Wednesday after House Republicans passed a budget blueprint which may grow the deficit by $3 trillion over ten years, the bigger picture is one of weaker data as evidenced by Citigroup’s Economic Surprise Index slide to a five-month low.
There’s “a risk-off tone as worries continue to mount regarding the impact of President Trump’s agenda on the performance of the global economy,” Ian Lyngen, the head of US rates strategy at BMO Capital Markets, said in a note.
US Treasury Secretary Scott Bessent fueled the bullish wagers Tuesday — a day after Trump confirmed that tariffs on Canada and Mexico are set to go into effect next week — by saying during an event in Washington, that 10-year yields should “naturally” drop with Trump’s policy.
One standout position targeting a 10-year yield drop to 4.15% and beyond emerged Tuesday morning. Around $60 million was spent on the bet, which stands to garner profits of approximately $40 million should yields drop as low as 4%, according to calculations by Bloomberg. If yields re-test the September lows, the position stands to amass a fortune of roughly $280 million.
Derivatives traders are also targeting yields on shorter-dated notes. Over the past few sessions there has been a growing long position amassed in fed funds futures, which stands to benefit from a Federal Reserve interest-rate cut as early as the May 7 policy meeting. Open interest, or the amount of futures positions held in the May contract, has risen by over 50% since the start of last week as traders price in more central bank easing over the course of this year.
Fed swaps are now pricing in around 32% probability for a May rate cut versus just an 8% chance a week ago. Up until this week, a narrow range of Fed policy outcomes have kept yields in a tight range.
In the cash market, traders are also starting to turn more bullish. A survey of JPMorgan’s Treasury clients showed that in the week up to Feb. 24 net long positions had risen to the most since Jan. 27.
Here’s a rundown of the latest positioning indicators across the rates market:
In the week up to Feb. 24, JPMorgan’s Treasury client survey showed outright longs rise 3 percentage points, taking the net positioning among clients to the longest since January. Outright short positions dropped 1 percentage point on the week with neutrals dropping 2 percentage points.
The options hedging premium in Treasuries has extended over the past week to increasingly favor traders paying-up to hedge a rally in the long-end of the curve, to the highest price since August. This is shown by the put/call skew on long-bond futures, which has continued to rise, favoring calls. A standout flow in the options market on Monday included a short-term hedge in 10-year tenor, targeting a yield drop to around 4.2% by March 7 expiry. Another recent popular theme in Treasury options have been short vol expressions via strangle and straddle sales. Monday’s action included a $5.3 million play via seller of straddles in the April tenor, before Tuesday’s $60 million premium spent on targeting a 10-year yield drop to around 4.15%.
Open interest has surged over the past week in two options mainly, the Sep25 96.50 and 96.25 calls, where positioning has extended through the 100,000 mark in each strike. One recent standout flow has been the consistent adding to a dovish hedge, targeting a couple of rate cuts by the middle of this year, via an outright buyer of the 96.25 calls in a long position which has built up to around 110,000 as of Monday’s close. The rise in SOFR Sep25 calls has been down to recent buying of the strike vs. selling the Dec25 97.00 calls as a spread.
In SOFR options out to the Sep25 tenor, the most-populated strike remains at 96.00. There has also been a recent rise in activity around the 95.875 strike. The 95.625 strike remains heavily populated with recent flows including decent buying in the SOFR Sep25 95.875/95.625/95.375 put fly.
In CFTC positioning up to Feb. 18, hedge funds aggressively covered short positions in 10-year note futures, by an amount equivalent to approximately $10.3m/DV01. The overall amount of net short covering across the futures strip from hedge funds was equivalent to approximately 340,000 10-year note futures, the biggest amount of short covering since November. Asset managers over the week unwound net long duration by approximately 151,000 10-year note futures, with the largest net unwind seen in the 5-year note futures.
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