(Bloomberg) — Investors are leaning into bullish bets on US Treasuries ahead of this week’s inflation report, as a recent run of softer-than-expected data opens the door for the Federal Reserve to cut interest rates in September and further ease monetary policy in the months ahead.
The market’s dovish stance has been reflected in open interest, or the amount of new risk held by traders: Some 70,000 contracts were added in October fed funds futures following Friday’s lackluster employment report, the largest daily increase on record for that month.
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In SOFR options, which closely track the Fed’s policy path, a number of large positions have emerged that look to benefit from an outsized cut of 50 basis points at next week’s meeting, though such a move is seen as unlikely.
“It’s now a lock that the Fed will cut interest rates at their meeting next week and that further rate cuts will follow in the months ahead,” said Bill Adams, chief economist for Comerica Bank. “The question is by how much.”
Yields on the US 10-year Treasury have dropped from a July peak to their lowest levels in around five months, as bonds rallied after a series of reports suggested that the US economy is cooling. Friday’s data from the Bureau of Labor Statistics further bolstered that view when it showed nonfarm payrolls increased by just 22,000 in August while unemployment rose to its highest since 2021.
In early London trading, the 10-year yield was down 1 basis point at 4.08%. The yield on two-year notes, which are sensitive to moves in rates pricing, slipped 2 basis points to 3.54%.
On Tuesday, a BLS report showed the number of workers on payrolls through March will likely be revised lower by a record 911,000. Investors are now awaiting a report on consumer prices, due Thursday.
Going Big
Wall Street has scrambled to adjust forecasts for what many now expect to be a more aggressive trajectory of rate cuts. Economists at Barclays, for instance, now see a quarter-point rate cut at each of this year’s three remaining meetings, from a previous forecast of just two cuts for the remainder of 2025.
Though interest rates swaps currently price in a full 25 basis point cut for next week, the run of weak data has emboldened some market participants looking for a heftier move.
“We recognize that we are moving early,” said Steven Englander, global head of G10 FX Research at Standard Chartered, in a report ahead of Tuesday’s data on revisions. “But we expect preliminary revisions to employment data for April 2024 to March 2025 to support our 50-bps call.”
Others are less sure the Fed will be that aggressive in September or the months ahead. Fed swaps on Tuesday were pricing in a combined 67 basis points of easing over the three remaining meetings this year, around 8 basis points short of three quarter-point moves.
A 50-basis point cut “would scare the market, as they would ask, ‘are we missing something that the Fed knows about?,” said Jeff Given, senior portfolio manager at Manulife Investment Management.
If employment data recovers in September, “then the Fed may say they can cut at every other meeting for a little time,” he said.
Here’s a rundown of the latest positioning indicators across the rates market:
JPMorgan Treasury Client Survey
JPMorgan’s Treasury client survey showed longs rise by two percentage points and shorts unchanged on the week at the highest since early February.
Most Active SOFR Options
In SOFR options, across Sep25, Dec25 and Mar26 tenors over the past week there was a heavy amount of new risk added in the 96.25 strike, largely due to demand for Sep25 calls via positions such as SFRU5 96.1875/96.25 call spreads, while there was also outright buying in the strike used to target a half-point Fed cut at the September meeting. There was also demand for SFRZ5 96.00/96.125/96.25/96.375 call condors over the past week. December call condors have also been popular over the past week with flows including SFRZ5 96.1875/96.3125/96.50/96.625 call condors and SFRZ5 96.25/96.375/96.50/96.625 call condors
SOFR Options Heatmap
In SOFR options across Sep25, Dec25 and Mar26 tenors, the 96.125 strike remains the most populated, where a large amount of Sep25 calls lie, largely due to a massive position in the SFRU5 96.125/96.25 call spread which has been built over recent weeks to a size in the region of 350,000 options. The 95.625 strike also contains a heavy amount of open interest largely due to positioning in Sep25 puts and Dec25 calls. There also remains a large amount of 95.75 Sep25 puts in open positions.
Treasury Options Skew
Treasury options skew in the long-end of the curve has flipped to favor calls in recent sessions, indicating that traders are paying a small premium to hedge a rally in the long-end vs. a selloff, as 30-year yields continue to stretch away from a 5% level.
CFTC Futures Positioning
In the week ending Sept. 2, asset managers added to net long duration, increasing longs across most Treasury futures tenors. They were most bullish in 10-year note futures, where net long position was extended by around $6.6 million per basis point in risk. On the flip side, hedge funds were bearish 10-year note futures, where net short position was extended by around $5.5 million per basis point in risk.
–With assistance from Carter Johnson and Naomi Tajitsu.
(Updates with latest prices in sixth paragraph)
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