Bond Traders Trim Fed Rate Cut Bets to 40bps, Treasury Shorts Revived

Key Takeaway

• Bond traders are now pricing in 40 basis points of Fed rate cuts by year-end, down from 50 basis points last week.
• New short positions have emerged as yields rise, while long positions on mature government bonds are partially unwound.
• JPMorgan's latest survey shows a bullish tone with net longs at the largest position in weeks, as client shorts shift to neutral.

Fed Rate Cut Doubts

Bond traders are increasingly skeptical that the Federal Reserve will deliver the two interest rate cuts that were priced into the swaps curve just last week. Currently, the swaps market is pricing in around 40 basis points of rate cuts by the end of the year, with the first full 25 basis point cut expected at the November policy meeting. This is a shift from the immediate aftermath of last Wednesday’s benign inflation reading for April, when markets had priced in closer to 50 basis points of cuts, or two 25 basis point moves.

Fed Governor Christopher Waller emphasized the need for more data before considering rate cuts. "If we get enough data going the right way, then we can think about cutting rates later this year, beginning of next year," Waller told CNBC. He noted that while April's consumer price figures were reassuring, "several more months of good inflation data" are needed before he would support easing monetary policy.

Market Positioning Shifts

Recent market movements reflect a cautious stance among traders. Positioning suggests that new short bets have been rebuilt as yields pushed higher, while long positions on more mature government bonds were partially unwound. This cautious approach is driven by the anticipation of more data to confirm the direction of inflation and fresh clues on the Fed’s policy path from the latest Federal Open Market Committee (FOMC) meeting minutes expected on Wednesday.

In the options market, there has been a notable increase in short-volatility bets, an investing strategy that pays off if the market remains stable. Demand for hedging a move lower to 4.3% in 10-year yields picked up last week and continued this week. JPMorgan’s latest survey of Treasury clients showed a more bullish tone, with net longs back to the largest position in a couple of weeks as short positions shifted into neutral.

Duration and Treasury Options

Asset managers have been adding to net duration long positions for the fifth consecutive week, equivalent to around 290,000 10-year note futures. Since April 16, the overall duration long among investors has increased to over 7.5 million contracts, a record amount. Conversely, hedge funds have added to net duration short positions by around 145,000 10-year note futures equivalents, bringing their net duration short to almost 7 million contracts.

The cost of hedging moves in Treasuries via the options market remains broadly neutral. The recent premium to hedge a selloff in the long-end of the curve has unwound over recent weeks. The most active options over the past week have been the 94.625 and 94.875 strikes, with significant open interest in put strikes attached to the SOFR Sep24/Dec24 94.875/94.625 put spread/spread position.

Street Views

• Christopher Waller, Fed Governor (Cautiously Optimistic on US monetary policy):

  "If we get enough data going the right way, then we can think about cutting rates later this year, beginning of next year... Several more months of good inflation data are needed before he would back the Fed easing its monetary policy."