Following U.S. President Donald Trump's nomination of Kevin Warsh for Federal Reserve Chair, short-term rate investors have initiated hedging strategies to protect against the risk of more aggressive policy easing this year than is currently priced in by markets. Options flows tied to the Secured Overnight Financing Rate (SOFR) since Trump's Friday announcement reveal market bets that Warsh, if confirmed by the Senate, will steer policy in a more dovish direction after assuming the role, potentially by the June Fed meeting. Swap traders currently anticipate the next 25-basis-point rate cut in July, with an inclination towards one additional cut before year-end. However, data from CME Group indicates that new SOFR options positions established on Friday included bets on two rate cuts by the end of September. Further hedging demand emerged during Monday's session to guard against the possibility of even more easing being priced into the third quarter. U.S. Treasuries edged lower on Wednesday, with yields broadly rising 1 to 2 basis points across maturities. The 10-year Treasury yield hovered around 4.28%. President Trump's persistent pressure on incumbent Chair Jerome Powell to cut rates has led market observers to speculate that Warsh's stance aligns with the President's. Warsh has also criticized the Fed's substantial balance sheet, fueling expectations that he would advocate for reducing its $6.6 trillion size. Given that such a reduction could tighten financial conditions, there is concurrent speculation that he might push for interest rate cuts to offset this effect. "A fairly reasonable assumption is that he simply would not have been considered for the position if he were not from the rate-cutting camp," said Steven Major, Global Macro Advisor at Tradition Dubai, in an interview. Concurrently, a J.P. Morgan survey of its clients showed a reduction in long Treasury positions and an increase in short positions, resulting in a net neutral stance for the first time since last October. The unwinding of long bets coincides with a concurrent steepening of the U.S. Treasury yield curve, partly driven by Warsh's views on the Fed's balance sheet causing longer-dated bonds to underperform shorter-term securities. On Monday, the yield spread between 5-year and 30-year Treasuries widened to its largest gap in three weeks.
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