Bond traders who accumulate a historic level of risk for low-rate bets

(Bloomberg) — Bond traders are taking on a record level of risk as they bet big on a rise in the Treasury market fueled by expectations that the Federal Reserve will begin its first interest rate cut in more than four years.

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The number of leveraged positions in Treasury futures rose to an all-time high ahead of the central bank’s annual economic symposium in Jackson Hole, Wyoming, which begins on Thursday. At the event, Fed Chairman Jerome Powell will speak and provide more information on the central bank’s monetary policy path for the rest of this year.

Open interest in futures contracts, or the amount of risk taken by traders that can be long or short positions, peaked at a record nearly 23 million equivalent 10-year futures contracts last week, CME Group Inc. data showed. and Bloomberg analysis. That’s about $1.5 billion in risk for every one basis point move in the underlying notes.

The increase coincides with an uptick in bullish bets over the past two weeks calling for aggressive rate cuts this year and 2025. Asset managers expanded net long positions by about 120,000 equivalents of 10-year futures, according to Commodity Futures Trading Commission data for the week ending August 13.

While most of the leveraged positions are asset managers going on Treasury futures, some of that can be attributed to the underlying trade, a popular hedge fund strategy where traders make money on the difference between cash Treasuries and futures.

Because this strategy involves borrowing in the repo markets, if credit conditions tighten, traders may be forced to cash out their positions to repay their loans. Such rapid easing could cause volatility in the Treasury market.

Traders, who have been concerned about the timing and size of Fed rate cuts, have been betting on a wide variety of scenarios that could play out this year. Just two weeks ago, the swaps market was pricing in a half-point rate cut at the Fed’s September meeting, along with some risk of an emergency rate cut at the meeting. Currently, about 30 basis points of cuts are being assessed for next month.

The cash market is already showing signs that the once-extensive bullish bet may begin to relax ahead of Jackson Hole. The JPMorgan Chase & Co. survey. for Treasury clients, released on Tuesday, showed the net long position shrank to the lowest amount in a month.

Here is a description of the latest rate market positioning indicators:

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The JPM survey

For the week ended Aug. 19, JPMorgan’s survey of Treasury clients showed a 6 percentage point decline in long positions, leaving net long positions at least in about a month, with short positions increasing 5 percentage points over the week.

Hedging Premium Facilities

The premium paid to cover market moves continues to fall back towards neutral after rising a few weeks ago to favor the call premium as traders looked for continued growth in the bond market. Tuesday’s flow of Treasury options included a $5 million long-term bet by a stranglehold buyer on October options, which expire two days after the Fed’s Sept. 18 policy announcement. Towards the end of last week, the theme of traders targeting higher 10-year yields was seen through strong flows around September and October 10-year put options.

Flows of change

While volume in SOFR futures and options has decelerated over the past two sessions, flows around the September tenor are now focused toward Fed policy moves of 25 basis points and away from potential half-point rate cuts to September meeting. Last week’s flows also appeared to include the withdrawal of half-point bets, which led to some heavy liquidation seen in some strikes on December 24 and March 25. The biggest cash outflows over the past week have been in the 97.00 and 96.00 call strike on December 24, as a result of the abandonment of an existing 96.00/97.00 call spread structure and a move to a new 96.50/97.50 position.

Heat map for SOFR options

In SOFR options to March 2025, the 95.50 strike is now the highest in open interest, having seen an increase during the Dec25 call week by trading the call 96.00/96.50/97.00/ 97.50 (see details) above).

Extension of duration

There were some big changes in positioning for the week ended Aug. 13, with asset managers going long by about 120,000 10-year futures equivalents and hedge funds taking the other side and adding to net short duration by about 315,000 10-year futures. equivalents. Hedge fund bearishness in 10-year futures pushed the net short position to more than 2 million futures, a record amount.

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