Bets on a Treasuries rally are being fuelled by expectations that data will show economic weakness, prompting the Federal Reserve to cut interest rates in December. — Bloomberg
WASHINGTON: Bond traders are piling into Treasury options targeting a drop in the 10-year yield below 4% in coming weeks, betting a cascade of data will show the US economy is weakening.
Investors are bracing for updates on the labour market and inflation as the US government prepares to reopen after the longest shutdown in history.
Bets on a Treasuries rally are being fuelled by expectations that the data will show economic weakness, prompting the Federal Reserve (Fed) to cut interest rates in December.
Treasuries rallied on Wednesday, with the 10-year yield closing five basis points lower at 4.07%.
The market held gains even after the government said reports on unemployment and the consumer price index for October are unlikely to be released.
White House Press Secretary Karoline Leavitt expressed concern that the lack of data is “leaving our policymakers at the Fed flying blind at a critical period.”
Traders scooped up bullish hedges on Tuesday as the cash market was closed for the Veterans Day holiday.
One position, bought for a combined premium of US$45mil, is targeting the 10-year yield to drop to as low as 3.9%.
Weekly private-sector jobs data released by ADP Research on Tuesday showed job losses that spurred a rally in futures.
The gains also held after the Treasury’s US$42bil 10-year note auction on Wednesday was awarded at 4.074%, compared to a yield of 4.068% just before the bidding deadline, a sign demand fell short of expectations.
Treasuries “have evolved back into a more normalised rate environment,” said Gregory Faranello, head of US rates trading and strategy for AmeriVet Securities.
“Inflation is going nowhere fast, jobs too and if I’m a policymaker, I’d play it cool with a bias lower.”
He doesn’t rule out 10-year yields falling again below 4%, a level they breached in mid-October before bouncing.
Open interest, or the amount of new positions held by traders, has rapidly risen in bullish options over the past week, targeting a bigger Treasuries rally.
The trades have been focused in both the December and January options, which expire Nov 21 and Dec 26.
Most of the buying has occurred in strikes which equate to a 4% yield on 10-year Treasuries, and the options start to make money in a bigger rally taking yields below that level.
On Monday, traders were back buying into a popular position in January call options. Open interest in the 113.50 strike has risen by over 600% in the past week.
Monday’s flows cost a premium of roughly US$40mil, on top of around US$70mil spent last week on the same trade, which stands to profit on US 10-year yields dropping below 4%.
Premiums paid to hedge a bond market rally over a sell-off are also starting to rise as momentum builds behind the bullish hedges. In US 10-year options the amount of open interest in calls is currently about 1.7 times more than puts.
Meanwhile, in the cash market, a bullish scenario is also unfolding. Wednesday’s JPM survey of Treasury clients showed the net long position among investors jumping to the biggest since the first week of April. — Bloomberg
