(Bloomberg) -- Bond traders are beginning to cash out of their bets for a further rally in US Treasuries as they scale back on expectations the Federal Reserve will deliver another half-point interest-rate cut.
The unwind comes days ahead of the September jobs report which will provide the latest read on the health of the labor market. Fed Chair Jerome Powell on Monday said policymakers will lower rates “over time” as the US economy remains on solid footing. The remarks triggered the biggest open interest drop since Sept. 6 in 10-year note futures, and yields for that tenor climbed 3 basis points on the day in a signal of traders taking off some long positions.
There’s tension in the market “between structural longs where profits are getting squeezed versus recent short profits and steepeners,” Citigroup Inc. strategist David Bieber said.
The profit taking is occurring as the swaps market continues to price in diminishing odds of another half-point rate cut at the November Fed policy meeting. Currently, about 34 basis points of cuts is priced into the market, or around a 36% odds of another over-sized reduction compared to a 60% chance just a week ago.
The past couple of trading sessions in the options market linked to the Secured Overnight Financing Rate, which closely follows central bank policy, has also reflected a similar sentiment as traders start to favor hawkish hedges, targeting just two quarter-point rate reductions over the remaining Fed policy meetings scheduled for the year.
According to the latest Commodity Futures Trading Commission data, both asset managers and hedge funds remained net long SOFR contracts, a possible source of the increased demand for options protecting against higher policy rates than current market expectations.
Meanwhile, the Treasury market got a lift Tuesday as investors flocked to safe havens after Iran launched a ballistic missile attack against Israel.
Bullish traders will be looking to Friday’s jobs report for more hints as to whether they should further cash out on their long Treasury bets. If the data comes in better than expected — reflecting a resilient job market — it could send yields higher and further diminish expectations that the Fed will move to slash rates by half a percentage point in November.
Here’s a rundown of the latest positioning indicators across the rates market:
JPMorgan Survey
In the latest week, JPMorgan’s Treasury client survey also showed signs of an unwind in crowded long positioning as clients’ short positions rose 6 percentage points to the highest in nearly a year. The net long position subsequently shifted to the smallest since April 8.
Long SOFR Futures
Positioning in SOFR futures remains net long for both asset managers and the leveraged-fund community, signaling that they are preparing for more rate cuts. In the week up to Sept. 24, asset managers unwound net long SOFR futures positioning by $3.8 million per basis point in risk while hedge funds extended net long by approximately $1.5 million per basis point in risk.
In Treasury futures, over the reporting week asset managers cut net duration long by around 13,000 10-year note futures equivalents while hedge funds covered around 51,000 10-year note futures equivalents to duration short position.
Most Active SOFR Options
Over the past week most open interest gains were seen in the 97.75 and 98.75 SOFR options strikes following stand out flows including a large buyer of the Mar25 97.75/98.75 2x3 call spread, looking to target two half-point rate cuts for this year. There were also weekly gains in the 96.25 strike following flows including SFRZ4 96.125/96.25/96.5625 broken call tree bought at even.
SOFR Options Heatmap
In SOFR options out to the June 2025 tenor, the 95.50 strike remains the most elevated with a vast amount of both Dec24 calls and puts occupying the level. There has been some recent outright buying of Dec24 95.50 puts adding to open interest in the strike. There has also been elevated downside activity including SFRZ4 95.625/95.50 put spread bought with SFRZ4 95.5625/95.4375 put spread at 1. Recent flows around the 96.00 strike have included buyer of the SFRZ4 96.0625/96.00/95.9375 put fly.
Options Premium Close to Neutral
The premium paid to hedge the Treasury market continued to hover near neutral over the past week across all tenors, after spiking a few weeks ago to favor a call premium as traders looked for a continued market rally. In the long-end, recent move to hedge a selloff has moved closer to neutral, potentially reflecting some fatigue to the popular steepener trade.
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