Treasury shorts surge as traders position for further rate hikes
TOP STORY: Bond investors have built up bearish positions across the US rates market ahead of this week's Federal Reserve meeting, as rising inflation risks and higher oil prices fuel expectations that interest rates could move higher and Treasury yields remain elevated, according to a report by Bloomberg.
Treasury bond investors have amassed bearish positions in the U.S. rates market ahead of this week's Federal Reserve meeting, driven by concerns over inflation and higher oil prices, according to Bloomberg. The 10-year Treasury yield hit its highest level since 2007 on Tuesday, while the two-year yield peaked since 2024. These developments coincided with a significant surge in short positions, signaling investors' wariness of purchasing government debt after recent declines.
JPMorgan's latest client survey revealed a 10 percentage point increase in short positions, with many investors who were previously neutral now adopting bearish stances. This shift left the survey with its lowest net long positioning in nearly four months.
Investors have also augmented Treasury futures shorts prior to and following last week's inflation data, indicating anticipation of higher interest rates from the Fed. The market now assigns a probability of over 90% for a 25-basis-point rate hike during the September meeting, marking the first increase since 2023. Factors contributing to this shift include heightened inflation risks, elevated oil prices due to the Iran conflict, persistent inflation, and apprehensions regarding U.S. fiscal policy.
JPMorgan's head of global research and investment strategy, Jason Thomas, highlighted the Federal Reserve's "enormous pressure" to raise rates by 25 basis points, citing the adverse impact of price hikes on households.
For bond investors, the risk extends beyond the immediate policy decision. If the Fed fails to raise rates or provides insufficient guidance on further tightening, longer-dated yields could climb as investors demand greater compensation for inflation risk. Conversely, shorter maturities may decline if markets believe the central bank is less inclined to continue tightening.
Some traders seem to be anticipating such an outcome, with increased demand for short-term interest-rate options on contracts linked to the Secured Overnight Financing Rate (SOFR) in October and November. This enthusiasm extends to other maturities, like SOFR options in December 2026, March 2027, and June 2027, accumulating significant new risk around the 95.4375 strike.
Notably, around 80,000 positions were taken in December 2026, March 2027, and June 2027 contracts, with a combined premium exceeding $100m, as per market data. Open interest in these options remains concentrated around the 96.50 strike, where substantial December 2026 call positions persist.
Following last week's inflation report, traders have also bolstered downside protection in select short-term rate structures, anticipating that further Fed tightening may be priced into front-end futures in the coming months. Treasury options similarly reflect caution toward duration, with the cost of downside protection on long-dated Treasury futures surpassing that of upside exposure, suggesting that traders are paying more to hedge against another sell-off in longer-maturity government bonds.
In contrast, options skew across the two-year through 10-year maturities remains relatively neutral.
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