Bond traders are piling into positions targeting multiple Federal Reserve interest-rate hikes in the coming months, with some looking for a move as early as the September policy meeting.
That’s the theme in the options market linked to the Fed-sensitive Secured Overnight Financing Rate, where traders have been increasing wagers on rate increases ever since Friday’s surprisingly strong US employment report, which sent the bond market tumbling.
Friday saw a flurry of activity involving multiple trades that stand to gain in the event of at least one rate hike this year, with options volumes SOFR Options See New Hedges for Fed Rate Hikes: Open Interest usual levels. The action SOFR Options Trade Targets at Least One Fed Hike by September even as the cash market recovered somewhat as oil and stocks slumped. One standout trade looking to target at least one hike and possibly two by the mid-September gathering.
The swift move toward hawkish protection followed a report on US job growth topping all forecasts in May, the clearest sign yet that the labor market may be breaking out from a prolonged period of lackluster hiring. Next up comes a key inflation report Wednesday that’s expected to show continued pricing pressures.
“The combination of stronger payrolls and uncomfortably elevated inflation has left markets penciling in higher odds of the Fed having to tighten policy,” said Gennadiy Goldberg, head of US rates strategy at TD Securities. “This has continued to leave yields elevated, though risk-off moves in equities appear to be helping to backstop yields.”
The bearish sentiment in the options market has been matched in futures, which are now pricing in a full quarter-point rate hike by the end of the year. Heading into the payrolls print, hedge funds had ramped up a net short position in SOFR futures to the most on record, the latest CFTC data showed.
“Short momentum still dominates,” wrote David Bieber, a strategist at Citigroup Inc. in a report Tuesday.
To be sure, these leveraged short positions could also be linked to strategies such as basis trades against cash or swaps, as well as convexity hedging or outright directional views.
A deepening bearish futures position would leave SOFR futures vulnerable to short-covering flows should the conviction around rate hikes start to falter. Wednesday’s May consumer price data could act as a brake on such positioning should it come in softer than expected, or alternatively act as a launchpad for additional hawkish options flows if it’s stronger than forecast.
Elsewhere, in the cash market, this week’s JPMorgan Chase & Co. Treasury client survey saw a small reduction in short positions, shifting into a neutral stance.
Here’s a rundown of the latest positioning indicators across the rates market:
JPMorgan Treasury Client Survey
In the week up to June 8, investor outright short positions were cut by two percentage points, shifting into neutrals with longs unchanged on the week. The all-client survey now shows the fewest outright shorts since May 4.
SOFR Options Positioning
Across SOFR Jun26, Sep26 and Dec26 options, there was a large amount of new risk added over the past week across Dec26 puts largely due to heavy buying in the SFRZ6 96.125/96.00/95.375 broken put tree. For position liquidations over the past week, open interest dropped significantly across a number of strikes in Jun26 calls and puts. Flows for position unwinds included SFRM6 96.3125/96.375/96.4375 call fly sales and SFRU6 96.875/98.625 call spread buyers.
The 96.50 strike remains the most populated, where a notable amount of Jun26 and Dec26 call positions sit. Recent popular positions around the 96.50 strike have included buyer of SFRU6 96.125/96.25/96.375/96.50 call condors with SFRM6 96.3125/96.375/96.4375/96.50 call condors. Over the past week SFRZ6 96.50/97.00/97.50 call trees have also been bought in good size for new risk. Also, the 96.375 strike has been added to over the past couple of weeks, where flows have included buyer of SFRZ6 96.3125/96.375/96.4375 call flies.
Treasury Options Skew
The premium paid to hedge options in long-bond futures remains well skewed toward puts, indicating traders paying a premium to hedge a bond selloff in the long-end of the curve over a bond rally. The skew on options from 2-year note futures out to 10-year note futures continues to trend back toward neutral level.
