Fed Rate Cut Expectations Fade, US Treasury Bear Bets Emerge

The Zhitong Finance APP has noticed that traders have begun to bet on losses in the U.S. Treasury market, as they anticipate that the Federal Reserve will cut interest rates at a slower pace in the future.

Since the release of the strong September employment report late last week, bond traders have been abandoning their long positions in multiple futures contracts linked to the Secured Overnight Financing Rate (SOFR). This indicates that bullish bets on a series of significant rate cuts at the end of this year and early 2025 have been unwound.

Meanwhile, short bets have begun to emerge. A financial client survey by JPMorgan revealed that this move has led to the largest direct short position in the spot market since February 2023.

Citigroup strategist David Bieber wrote in a report on Tuesday: "The market has a preference for new short risks before the inflation data is released this week."

Since the release of the employment report, the open interest data of SOFR futures (i.e., the number of positions held by futures market traders) has decreased significantly. Data released by the Chicago Mercantile Exchange on Tuesday showed that within the December 2024 term, the position reduction over two days has reached about 223,000 contracts, equivalent to a risk of $5.6 million per basis point. During this period, the contract was heavily sold off, indicating that as traders reprice the Fed's policy path for this year as less aggressive easing, bullish bets have been erased.

The key inflation data to be released on Thursday may further disrupt traders' bets on monetary policy, with short positions being formed in advance. The latest Consumer Price Index (CPI) is expected to slow down further, but if the index strengthens, investors may still make a significant shift to short positions.

The market currently expects the Fed's policy meeting on November 7 to cut interest rates by about 21 basis points, with a total reduction of 50 basis points in the remaining two meetings of the year. Before the release of the non-farm employment data, the December meeting was expected to cut interest rates by about 66 basis points.

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Long positions in the spot market are also disappearing. The latest client survey by JPMorgan Treasury showed that net short positions among traders last week appeared for the first time since April 2023.

Meanwhile, since the release of the non-farm employment data last Friday, the new positions in the SOFR options market have been biased towards hedging, aiming for the Fed to gradually cut interest rates by 25 basis points in November, and then pause the rate cut in December.

JPMorgan surveyAs of the week ending October 7th, JPMorgan clients reduced their long positions by 9 percentage points, while short positions increased by 3 percentage points. This resulted in the largest short position since February 2023. Neutral positions remained high at 67 percentage points, rising by 6 percentage points this week.

The most significant position changes in the past week occurred in the strikes associated with the December 2024 put options, as traders looked to add put positions following last Friday's employment report and the subsequent repricing of the Federal Reserve's policy path. A notable flow was the substantial purchase of the December 24th 95.5625/95.4375 put spread, with the position targeting only a 25 basis point rate cut in each of the remaining two policy meetings this year.

SOFR Options Heatmap

Among the SOFR options expiring in June 2025, the 95.50 strike line remains the most crowded, with a significant amount of both call and put options at the December 24th level. Recent flows around the strike have included direct buying and downside activity, including the purchase of the SFRZ4 95.625/95.50 put spread and the SFRZ4 95.5625/95.4375 put spread.

Hedge Funds Cover Short Positions

CFTC data shows that, in the week ending October 1st, leveraged funds covered approximately 57,000 equivalent 10-year Treasury futures net short positions. During the same period, asset managers added about 152,000 equivalent 10-year Treasury futures to net long positions. In SOFR futures, for every basis point of risk, asset managers would close out around $4.4 million.

Bond Put Option Premiums Begin to Rise

The premium paid to hedge the U.S. Treasury market has once again tilted towards put protection, indicating that dealers are paying higher premiums to hedge against the sale of U.S. Treasury bonds during a rebound. The premium is highest on the long end of the yield curve, which can be seen from the put-heavy long-term bond options. This shift triggered a market sell-off, with the 10-year Treasury yield rising to a high of 4.05% on Tuesday, the lowest level since early August.