Traders make late dash into bets Fed stays higher for longer

Options traders are seeking protection from higher interest rates ahead of Wednesday’s Federal Reserve policy decision.

That’s a change from the norm over the past couple of weeks, during which traders broadly favoured hedging for a pivot to rate cuts by mid-2024. The shift in momentum has a backdrop of erosion in the amount of easing priced in for next year and subscription to the idea that the Fed will raise rates once more this year in November or December and keep them elevated indefinitely.

Wednesday’s policy announcement comes with updates to policy makers’ economic forecasts, including for the policy rate. That so-called dot plot is expected to show another rate hike by year-end. The recent break-out of the higher-for-longer theme is evident in futures linked to the Secured Overnight Financing Rate, where Friday saw record volumes in a spread trade linked to that narrative.

Meanwhile, JPMorgan’s latest Treasury client survey released Tuesday shows investors net long positioning rising to the highest in a month.

Here’s a rundown of positioning in various corners of the market:

New SOFR options risk

This week has seen a couple of large hawkish trades in March 2024 SOFR options, with highlights including heavy demand for both SFRH4 94.375/94.125/93.875 put trees and SFRH4 94.25/93.875 1×2 put spreads. Open interest following Monday’s session suggested new risk via hawkish hedges, mostly spread across the start of next year. In SOFR futures, demand on Friday surged for Dec23/Mar24 steepeners, a trade that stands to benefit from higher-for-longer Fed rates.

Fading rate-cut pricing

Fed-dated OIS markets have trimmed the amount of Fed rate cuts next year and beyond. Since September 1 one 25bp hike, and then some, has been erased for period through the end of next year.

Leveraged funds, asset managers trim positions

In latest CFTC positioning data for the week ended September 12, hedge funds cut their overall net short position by around 38 000 10-year note futures equivalents, while asset managers cut their overall net long exposure by approximately 51 000 10-year futures equivalents. Leveraged funds remain at elevated net short however, well above an amount equal to 6 million 10-year note futures.

Block trade summary

Activity in 5-year note futures remains elevated, with block trades well over any other tenor on the curve over the week ended September 18. Highlights included a 21 776 contract trade on September 13 at a level of 106-09+.

Hedging costs rise for long-end UST selloff

The cost of hedging for a long-end selloff is increasing in cost vs the front-end and belly of the curve, shown by the latest moves in skew levels in options for bond futures. As Treasury yields rose Tuesday, the 10-year exceeded its August highs, reaching the highest level since 2007.

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