Janice R. Andrews
At the moment, the $27 trillion Treasury market is humming with activity as investors are making large wagers on rising long-term bond yields. Wall Street’s expectation of Donald Trump’s possible comeback to the White House is primarily responsible for this change. Following Trump’s dominant performance in the first presidential debate versus President Joe Biden, investors have shown a clear pattern of purchasing notes with shorter maturities and selling off notes with longer maturities, according to the market. Since then, the “steepener trade,” as it is called, has become more and more popular.
An Increase in Visible Interest
Open interest, which is a gauge of traders’ level of risk-taking, increased significantly on Friday and Monday. This spike was accompanied by a growing difference in rates between the two- and 10-year bonds, which caused the curve to steepen by about 13 basis points. The biggest two-day steepening since October occurred with this move. The front-end yields gradually increased during the week, reducing the steepening effect somewhat.
Wall Street Strategists Offer Their Opinions
In response, Societe Generale SA’s director of US rates strategy, Subadra Rajappa, stated, “It’s still too early to fully price in an election outcome—but probably not too early to leg into it.” The market appears to be attributing increased probability of a Trump triumph based on the latest bear steepening move. In the event that Trump wins reelection, Wall Street strategists at Morgan Stanley and Barclays have been warning customers to brace for prolonged inflation and higher long-term bond yields.
Enhanced Interest in Steepener Transactions
The spike in open interest, which rose by a total of $15.7 million per basis point in risk, indicates the market’s demand for steepener trades. This indicator suggests that new short positions were the primary cause of the recent decrease in longer-dated Treasuries. It also shows that traders are actively seeking out new steepener trades.
Trading Activity That Is Anonymous
Although it is challenging to identify the precise companies placing these bets because to the anonymity of many deals, data shows a notable futures block steepener on Friday that is consistent with bets on a steeper yield curve. Similar trend is seen in the cash market according to data from JPMorgan Chase & Co. The most recent poll reveals a 5-percentage-point decline in bond rally bets, bringing the net long position down to its lowest level since June 10.
Movements in the Options Market
To protect themselves from a selloff in bond futures contracts, traders are paying the most premium in a month in the options market. There is increasing anxiety over a possible collapse in the long end of the yield curve, as evidenced by the move in premium from calls to puts.
Aligning Signals Throughout the Interest Rate Market
JPMorgan Customers Aren’t as Excited: JPMorgan clients decreased their long positions by 5 percentage points in the week that ended on July 1, moving them nearer neutral levels. During this time, short bets did not alter, and as a result, the net long position fell to its lowest level since June 10.
Premium for Options Turns to Puts: The cost to traders of hedging against a selloff in the long end of the curve is at its highest level since late May, when US 30-year yields reached a peak of 4.65%. One prominently negative position is to see 10-year rates go as high as 4.55% by the expiration date of August 23.
Short Net Futures Extended by Hedge Funds: The net short position in ultra-long bonds held by leveraged accounts reached its highest point since 2022. Hedge funds increased their total net short position for the week ending June 25 by around $10.8 million per basis point in risk, according to statistics from the Commodities Futures Trading Commission. On the other hand, asset managers kept a net long position equal to 93,000 10-year note futures, with notable additions to their bullish positions in all intermediates.
Ongoing SOFR Choices: Significant open interest growth were seen over the previous week across a number of September 2024 put strikes. Many put spreads and flies were among the flows; significant liquidations were observed between the 97.00 and 96.00 strikes, which were associated with significant condor transactions. Following recent flows, the SOFR options heat map displays strong open interest near the 94.625 strike, with active transactions also involving a variety of put flies and spreads.
With traders navigating an unpredictable political environment, the steepener trade, driven by the possibility of Trump’s comeback, is intensifying. Wall Street strategists have been pushing for measures to prepare for sticky inflation and higher yields on long-term bonds; the market is responding to the changing political and economic environment with caution and strategy. Undoubtedly, as traders and investors continue to respond to the unfolding electoral dynamics and their possible impact on the Treasury market, the upcoming months will see even more changes and adjustments.
