If the Federal Reserve adopts a more aggressive posture at its upcoming monetary policy meeting, bullish bets in the U.S. Treasury market could be at risk of a sharp reversal.
Although investors see little chance of a rate hike on Wednesday, hawkish signals from Chair Kevin Warsh on key issues such as inflation could prompt investors to reassess how high the Fed will ultimately push borrowing costs.
That could force painful unwinding of the large long positions traders have accumulated during the recent safe-haven rush into Treasuries.
"The biggest change ahead of the FOMC meeting is that the market has turned tactically long Treasuries and European bonds," wrote Citigroup strategist David Bieber.
He added that although the overall market structure remains bearish, traders have been building bullish positions to chase the bond rally.
Open interest data from CME shows that over the past week traders have been cutting short positions in Treasuries while betting that the rally, driven by concerns over the sustainability of the artificial intelligence trade and stress in the French bond market, will continue.
On Friday, there was large-scale liquidation in U.S. Treasury futures, particularly in contracts tied to 10-year notes.
A day earlier, Treasuries posted their biggest single-day gain in more than two years, with heavy new positioning in 10-year contracts, and changes in open interest suggested those positions may be long.
Meanwhile, JPMorgan's weekly survey showed net long positioning at its highest level since early September.
"Right now, the only thing truly standing between a rate hike and current market pricing is the guidance the Fed provides," said Ed Al-Hussainy, portfolio manager at Columbia Threadneedle.
"If views in the room shift, it is more likely to shift in the direction of a hike."
The Treasury rally has pushed the benchmark 10-year yield down to around 5%, reversing the bearish trend that persisted for much of 2025.
Earlier this month, signs of accelerating inflation and elevated oil prices briefly pushed the 10-year yield up to 5.36%, the highest level in more than 20 years.
Pricing in the swaps market shows about a 7% chance of a Fed hike on Wednesday, while the probability of a December hike exceeds 90%.
"The market is underestimating the possibility of an October hike," said Tracy Chen, portfolio manager at Brandywine Global Investment Management.
She said that if Warsh takes a hawkish stance, "we would see a bear flattening of the yield curve."
During Asian trading hours on Wednesday, the two-year Treasury yield held steady at 4.73%, while the 10-year yield hovered around 5%.
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