Robust US jobs data has ignited market expectations for a Federal Reserve interest rate hike, with US Treasury traders rapidly building bearish positions.
Last Friday's US May non-farm payrolls report, which surpassed all forecasts and signaled the strongest labor market recovery to date, directly spurred a wave of new positions in the SOFR options market betting on a rate hike, with some trades even pointing to a potential move as early as September. The SOFR futures market has now fully priced in at least one 25-basis-point rate hike for the year.
Wednesday's release of the US May CPI data will be the next critical juncture. If inflation figures exceed expectations, they will further reinforce rate hike expectations and drive more short positions. Conversely, if the data falls short, it could trigger a wave of short-covering in existing positions, offering the bond market some breathing room.
SOFR Options Market: Rate Hike Bets Intensify
Since the release of the jobs report last Friday, the SOFR options market, highly sensitive to Fed policy direction, has continued to absorb new bearish positions, with trading volume significantly higher than usual levels.
Several notable trades directly target at least one, or even two, rate hikes before the Fed's September policy meeting. Even as a decline in equities and softer oil prices provided some support for the cash bond market, bearish sentiment in the options market showed no signs of abating.
TD Securities US rates strategist Gennadiy Goldberg stated, "The combination of strong payroll data and persistently high inflation is prompting the market to further increase the probability of Fed tightening. This continues to keep yields elevated, even though safe-haven flows from equities have provided some support for yields."
SOFR Futures: Hedge Fund Short Positions Reach Record High
The bearish sentiment is not confined to the options market; clear signals are also present in the futures market. According to the latest report from the US Commodity Futures Trading Commission (CFTC), hedge funds had already increased their net short positions in SOFR futures to a record high before the jobs data release.
Citi strategist David Bieber wrote in a Tuesday report, "Short momentum remains dominant."
However, it is worth noting that these leveraged short positions do not solely represent a pure directional bet. They may also be part of hedge fund strategies involving basis trades between cash and swaps, or convexity hedging operations.
Should market conviction in a rate hike begin to waver, the heavily accumulated SOFR futures shorts would face a concentrated risk of covering, potentially triggering a short-term rebound in the bond market.
Options Position Details: Recent Bearish Structures Dominate, 96.50 Strike Most Concentrated
Looking at specific position distribution, new risk added to the SOFR market over the past week has primarily focused on Dec26 put options, with notable buying interest in the SFRZ6 96.125/96.00/95.375 put spread structure.
Concurrently, open interest for both calls and puts at various strikes for the Jun26 contract has seen a noticeable decline, indicating some positions have already been unwound and exited.
The 96.50 strike remains the most concentrated point for options market positioning overall, with call positions in Jun26 and Dec26 being particularly significant. Over the past week, there has also been substantial new positioning in the SFRZ6 96.50/97.00/97.50 call fly structure, reflecting some traders' hedging against a potential future rate cut path.
Regarding Treasury options skew, implied premiums for long-bond futures options continue to lean towards the put side, indicating traders are paying a higher cost to hedge against further yield increases at the long end. The skew for 2-year to 10-year Treasury futures options, however, continues to revert towards neutral levels.
Cash Market: JPMorgan Survey Shows Marginal Reduction in Shorts
In contrast to the bearish dominance in options and futures, sentiment in the cash market shows signs of marginal stabilization.
According to JPMorgan's weekly US Treasury client survey for the week ending June 8th, investors' outright short positions decreased by two percentage points, shifting to neutral, while long positions remained unchanged. The survey of all clients shows the current short percentage is at its lowest level since May 4th.
This divergence in signals suggests that, despite intensifying rate hike bets in the derivatives market, some participants in the cash market are beginning to cautiously approach the risk of excessive bearishness at the margin. Wednesday's CPI data will be a crucial moment to test the validity of the current pricing.
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