(Bloomberg) -- Bond traders who have been mired in a Treasury market slump are bracing for more of the same as Donald Trump’s inauguration approaches, with options indicating the potential for a spike in US 10-year yields to 5% — a level not seen since October 2023.
Speculation that Trump’s policies will spur both quicker inflation and higher deficits as the US economy chugs along has sent yields on 10-year Treasury notes soaring roughly half a point over the past month to near 4.7%. A rush of corporate-bond issuance and $119 billion of US debt auctions this week — with more government borrowing expected in the weeks ahead — has added to upside pressure.
“We need a little bit of certainty on fiscal policy and we will hear more about that as the inauguration takes place,” Gargi Chaudhuri, chief investment and portfolio strategist for the Americas at BlackRock Inc. “This unknown of more Treasury issuance coming to the market will keep the buyers away.”
Meanwhile, upbeat economic readings such as Tuesday’s data on job openings and the service sector have pushed out expectations for further Federal Reserve interest-rate cuts into the second half of the year.
Against this backdrop, investors are positioning for sharply higher yields. Options data Tuesday from the CME indicated a fresh trade targeting 10-year Treasury yields at 5% by the end of February. That may be just the start: Padhraic Garvey, head of global debt and rates strategy at ING Groep NV, sees 10-year US Treasury yields trading around 5.5% toward the end of 2025, while T. Rowe Price’s Arif Husain said 6% is within the range of possibility.
The recent surge in Treasury yields appears to have been accompanied by the buildup of short positions in the futures market. Open interest, a gauge of activity in the market, has risen in each of the past five sessions in the so-called ultra 10-year note contract, which tracks the generic 10-year cash note. Further out, open interest has risen in eight of the past nine sessions in the long-bond contract, which matches up against the 2040 cash bond. Rising open interest into a selloff broadly indicates new bearish wagers.
To be sure, even as yields have marched steadily higher, some investors see opportunity as the new trading year gets underway. JPMorgan Chase & Co.’s latest client survey showed long positions increasing to the biggest in more than a year, though short positions also grew over the past week.
Here’s a rundown of the latest positioning indicators across the rates market:
JPMorgan Treasury Client Survey
In the week leading up to Jan. 6, short positions as measured by JPMorgan’s client survey increased by 6 percentage points and longs rose 8 percentage points to the most since Dec. 4, 2023.
Treasury Options Premium Favoring Puts
The cost to protect against a selloff in the long end of the Treasury curve has risen over the past week, with the options skew favoring puts at its most elevated in about 15 days. The move matches the steady grind higher in yields over the past month or so, which has seen the 10-year reach its cheapest levels since the start of May. In Treasury options, this week’s flows have reflected put demand, with the standout trade being an $11 million premium wager targeting a 5% 10-year yield. There has also been good demand for weekly options, again favoring a bigger market selloff.
Most Active SOFR Options
Over the past week, there has been a decent amount of new risk added in the 96.4375 strike due to flows such as buying of the SFRU5 96.25/96.4375 seen over Friday’s session. Broadly, the rising open interest over the week has largely been due to bullish structures, with new positioning seen across multiple call strikes in Mar25, Jun25 and Sep25 tenors. Following Tuesday’s JOLTS and ISM services data, Fed-dated OIS shifted pricing of the first full 25bp of easing this year out to July from June.
SOFR Options Heatmap
In SOFR options out to the Sep25 tenor, the heaviest populated strike has been 96.00, largely due to heavy amount of Mar25 calls and Jun25 puts at that level. Recent flows around the strike have also included buyers of the SFRZ5 96.00/96.50/97.00 call fly, while the SFRH5 96.00/96.25/96.50 call fly has also been a popular trade.
CFTC Futures Positioning
Into the end of the year, hedge funds added to net short positions across the Treasury strip by approximately 124,000 10-year note futures equivalents, while asset managers added to net longs by approximately 72,000 10-year note futures equivalents. For hedge funds, the largest amount of new short risk was seen in the ultra 10-year note futures, where bearish positioning was extended by approximately $5.9m/DV01, CFTC data shows.
--With assistance from Michael Mackenzie.
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