As traders push up long-term bond yields on speculation the economy will avert a recession, they’re also dialing back expectations for Federal Reserve rate cuts. There’s around 100 basis points of easing now priced into the swaps market through next year, down from more than 150 a few weeks ago.
(Bloomberg) — As traders push up long-term bond yields on speculation the economy will avert a recession, they’re also dialing back expectations for Federal Reserve rate cuts. There’s around 100 basis points of easing now priced into the swaps market through next year, down from more than 150 a few weeks ago.
In options pegged to the Secured Overnight Financing Rate, a popular trade over the past week has been hedging the risk that interest rates will stay elevated through next year.
Meanwhile, block trades have been frequent in 5-year Treasury futures contracts, potentially exacerbating market moves during the traditionally light-liquidity month. That’s coupled with signs of growing short positions in the 5-year cash note, indicating a revival of basis trades that seek to exploit the difference between the futures and cash markets.
But overall, JPMorgan Chase & Co.’s latest Treasury client survey showed both long and short positions shifting into neutral ahead of Fed Chair Jerome Powell’s Friday speech in Jackson Hole, Wyoming, which may alter expectations for where the central bank’s policy is heading.
Here’s a rundown of positioning in various corners of the market:
Traders Price Out Fed Cuts
The 12-month Dec23/Dec24 spread in futures linked to SOFR has steepened sharply over the past couple of weeks as traders scale back rate-cut pricing for next year. Similar sentiment has been seen in SOFR options, where traders have targeted downside protection for next year and beyond, taking positions that will gain as more rate cuts are priced out of the market.
Block Trades Active
Further out on the curve, futures block trades remain active, with notable demand seen in the 5-year tenor. There were over 123,000 futures contracts blocked in 5-year notes last week, equivalent to approximately $5 million per basis point move in cash yield, over 16 trades. The belly of the curve has underperformed extensively over most US morning sessions during the past couple of weeks, shown by a cheapening of the 2s5s30s fly.
Related: Like Clockwork, Treasuries Belly Gets Hit in Early US Sessions
Asset Managers, Hedge Funds Diverge
In Commodity Futures Trading Commission data up to Aug. 15, asset managers added to net short positions in SOFR futures while hedge funds increased net long positions. Further out, as yields pushed higher, asset managers added to net long duration while hedge funds were bearish, indicating bets that the selloff had more room to run.
Treasury Hedging Costs Steady
Similar to last week, there remains a wide divergence between premium paid on hedging a long-end selloff versus one in the front-end or belly of the curve, though outright skew levels are less negative.
The most active SOFR options strike out to March 2024 remains the 95.00 — where recent activity around this level has included a buyer of the 94.875/95.00/95.125/95.25 call condor. A recent theme seen in SOFR options has been downside protection bought for 2024 and 2025, another signal of traders wagering on a steeper yield curve as expectations for Fed cuts are dialed back.
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