Bond traders have been spending millions of dollars to guard against sharp declines in long-dated Treasuries that risk igniting a bigger bout of volatility in the $31 trillion market.
The cost of hedging against a rise in Treasury yields has surged since last week as traders piled on Treasury put options on both US 10- and 30-year bond futures after long-bond yields climbed to a 19-year high. The flurry of trades came as the Federal Reserve held off an interest-rate hike, prompting investors to question Chairman Kevin Warsh’s determination to fight inflation.
“The Fed lost the market’s confidence after the last meeting,” said Molly Brooks, US rates strategist at TD Securities. In the absence of further forward guidance “we would expect higher volatility to continue as markets are more reactive to incoming data and shifts in Fedspeak,” she said.
The ICE BofA MOVE Index, a proxy of Treasury market volatility, is already coming to life, climbing to the highest level in about 10 weeks. The moves are spurring options flows targeting 10-year yields to rise to near 5% and 30-year yields to 5.4% — about 35 and 20 basis points respectively above current levels.
See more: Costs to Hedge Against a Deeper Selloff in US Bonds Are Soaring
Should yields resume their ascent and re-test multiyear highs, the newly embedded bearish options positioning could spark a deeper selloff. That’s as dealers will look to cover their exposure once strike targets come into view, by selling bond futures and fueling further market swings.
The options activity picked up pace during Warsh’s press conference last week with a huge position that looked to target 30-year yields rising to around 5.3%.
On Monday, buying of downside options continued. One position for a premium of almost $10 million targeted a 30-year yield move to around 5.5%, about 30 basis points above current levels.
Meanwhile, in the cash market, investors are also leaving the sidelines and putting money to work. Neutral positions in a Treasury client survey by JPMorgan Chase & Co. were at their lowest since the start of June as both outright long and short positions increased to multi-week highs over the week.
Here’s a rundown of the latest positioning indicators across the rates market:
JPMorgan Treasury Client Survey
In the week to Aug. 3, investors in JPMorgan’s survey increased both long and short positions. Long positions now sit at the most since the end of June, while investors are most outright short since June 15. Neutral positions subsequently shifted to fewest since the start of June.
Across SOFR Sep26, Dec26 and Mar27 options over the past week, the 95.8125 strike has been active with flows including buyer of SFRU6 96.00/95.8125 put spreads. Additional downside seen over the past week has included heavy buying in the SFRZ6 95.6875/95.5625 put spreads and SFRZ6 96.1875/96.0625/95.75/95.625 1x1x2x2 put condors. Broadly, open interest has been added across Sep26 and Dec26 puts, as traders have looked to hedge additional rate hike premium versus current market expectations via an array of downside structures.
The 96.375 strike is now the most populated across Sep26, Dec26 and Mar27 options with the 96.50 strike shifting down to the third most populated. Recent flows adding to the open interest in the 96.375 strike have included buyer of SFRZ6 96.3125/96.375 call spreads and SFRH7 96.375/96.625 call spreads. Existing positions around the strike have also included SFRZ6 96.375/96.50/96.625 call flies and SFRZ6 96.375/97.00 1×2 call spreads.
The premium paid to hedge long-bond Treasury futures has moved sharply to favor puts over the past week, where traders have been paying up the most compared to calls in around five months. Skews in 2-year notes out to the 10-year sector have also edged toward premium on puts from neutral over the past week.
With assistance from Cameron Fozi.
This article was generated from an automated news agency feed without modifications to text.
