As the buying pressure for US Treasury bonds gradually enters the market, will the "frightening surge in yields" that has been haunting the stock market ease soon?

According to the Wise Finance APP, as the long-term US Treasury bond yields hit their highest level since November last year, especially with the "global asset pricing anchor" beginning to attract opportunistic buyers worldwide, despite the deep-rooted negative sentiment in the entire US Treasury bond market. The latest client survey from Wall Street's major bank, Morgan Stanley, shows that as of Monday's US stock market close, investors' net long positions in US Treasury bonds are at their highest level in three weeks. At the same time, in the options trading market, traders seem to be inclined to at least partially close out some SOFR put positions, as the US 2-year Treasury bond yield soared to 5% this week, the highest level in a year, they may lock in profits. The escalating tensions in the Middle East may also provide buying support for US bonds with safe-haven properties, but it is still not enough to trigger a significant rebound.

Since the beginning of this month, prices of US Treasury bonds of all maturities have plummeted significantly, with yields soaring across the board. The main logic behind this is that traders have made aggressive reactions to economic data showing continued strength in the US economy and persistently high inflation, and the market has significantly lowered expectations of a rate cut by the Federal Reserve, triggering a surge in US Treasury bond yields, especially for the 2-year Treasury bonds which are most sensitive to interest rate expectations.

Due to the continued warming of expectations for a shift in Federal Reserve policy towards easing by the end of 2023 and the beginning of this year, the interest rate futures market had at one point bet on a 150 basis point rate cut by the Federal Reserve this year. With strong buying pressure and support for rate cuts, global bond investors experienced a barely positive bond price return after 24 consecutive months of decline in the "bond frenzy" at the end of last year.

However, with strong retail sales data and inflation data exceeding expectations for three consecutive months, highlighting the resilience of the US economy and sticky inflation, bets on a rate cut by the Federal Reserve in the interest rate futures market fell to as low as 25 basis points at one point, far from the 150 basis point expectation at the beginning of the year and the 75 basis points before the CPI announcement. The market bet on the timing of the first rate cut was significantly delayed from the once-bet March to November, later than the market's bet of June on the eve of the CPI announcement. Shaan Raithatha, a senior economist at Vanguard Group, a top US asset management company, recently stated that the firm's basic assumption is that the Federal Reserve will not cut rates in 2024.

In October 2023, the "global asset pricing anchor" once broke through the milestone of 5%, soaring to its highest level since 2007. The 10-year US Treasury bond yield single-handedly disrupted the trends of major global risk assets in the second half of 2023, and now the 10-year US Treasury bond yield has resumed its upward trend, inevitably causing concerns in the market about whether it will once again severely impact the prices of stocks, cryptocurrencies, and other risk assets.

From a theoretical perspective, the 10-year US Treasury bond yield is equivalent to the risk-free rate indicator r at the denominator end of the important valuation model in the stock market - the DCF valuation model. When other indicators (especially the cash flow expectations at the numerator end) have not undergone significant changes, or even in the case of a possible downward bias in expectations during the April US stock earnings season, if the denominator level is higher or continues to operate at historically high levels, the valuation of high-risk assets such as global tech stocks, high-risk corporate bonds, and riskier emerging market currencies faces the risk of collapse "Higher-for-longer" Sweeps the Market, but SOFR Options Market Starts to Show Dovish Bets

The aggressive expectation in the U.S. Treasury market for the benchmark interest rates to remain "higher for longer" has been fermenting, coupled with the hot inflation data released last week, completely wiping out the 4.2% price return rate that the global sovereign debt index had reached since 2023 as of last Thursday. The 10-year U.S. Treasury yield, known as the "anchor of global asset pricing," briefly approached 4.70% on Tuesday. Federal Reserve Chairman Jerome Powell stated on Tuesday that strong economic data may prompt the Fed to maintain high rates for a longer period, exacerbating market anxiety, with bearish sentiment towards U.S. and other sovereign bonds on the rise.

The ongoing negative sentiment in the U.S. Treasury trading market can be seen from the accumulation of bearish open positions in 2-year U.S. Treasury futures. With yields continuing to rise, there have been 13 out of 14 trading days in the past where new positions were evident, rather than closing positions.

Including Meghan Swiber, U.S. bank strategists wrote in a report on Monday, "Our U.S. Treasury futures positions proxy shows that yields tend to rise, especially in the short end like the 2-year." They added that CTA trading strategies have also begun to spread their short positions to longer maturities.

Although JPMorgan's survey shows some buying forces adopting a buy-on-dip strategy recently, other statistics such as the U.S. Commodity Futures Trading Commission (CFTC) data suggest otherwise. Since early February, CFTC data shows that asset management companies have reduced their net long positions in U.S. Treasuries for 8 out of the past 10 weeks, including the most recent week ending on April 9.

However, it is undeniable that some U.S. Treasury traders are hedging their bearish positions. In the options market related to the Secured Overnight Financing Rate (SOFR), there has been a protective hedging demand against the possibility of aggressive rate cuts by the Fed, with year-end SOFR dovish rate options hedging starting to offset some of the bearish bets on SOFR. The Secured Overnight Financing Rate is closely related to the Fed's monetary policy rate expectations.

Here is an overall overview of the latest position indicators in the interest rate market:

U.S. Treasury Clients Increase Long Positions

JPMorgan's survey of U.S. Treasury trading clients for the week ending on April 15 showed a 4-percentage-point increase in long positions, a 6-percentage-point decrease in short positions, a 2-percentage-point increase in neutral positions, and client net long positions rose to the highest level in three weeks. Given last week's report showing clients shifting to net neutral positions for the first time in nearly a year (instead of net long positions), the sudden trend reversal towards long positions may reflect investors' warming sentiment towards high-yielding U.S. Treasuries as quality safe-haven assets JPMorgan Chase's U.S. Treasury Client Position Survey - Net Long Position of Clients Rises to Highest Level in Three Weeks

Hedge Funds Show Replenishment Trend

According to CFTC statistics as of April 9th (the day before the latest U.S. CPI inflation report was released), hedge funds have unwound their short positions, continuing the trend since early January. The latest round of short covering is equivalent to about 112,000 10-year U.S. Treasury futures contracts, the largest since February 27th. Out of the 15 weeks since the beginning of this year, hedge funds have closed out their short positions in 11 weeks. On the other hand, asset management companies have been reducing their net long positions during the same period. The latest data shows that the "smart money" accounts have closed out nearly 100,000 contracts equivalent to their net long-term long positions in 10-year U.S. Treasury futures.

The Cost of Hedging Bond Sales Remains Very High

Despite a very brief safe-haven buying spree in U.S. Treasuries last Friday, the cost of hedging long-term Treasury sales remains high, especially compared to short and medium-term Treasury futures. Recent fund flows in the options market tend to hedge larger-scale sales, with standout trades including a $4.4 million bet on a 10-year Treasury yield of 4.65% on Monday. Tuesday's trading highlights include a $18 million bulk options selling trade, indicating a clear profit-taking signal as short positions are closed out when the 10-year yield hits a new annual high.

Most Active SOFR Options Trading

Over the past week, trading activity for SOFR 94.625 strike put options has increased significantly, with demand for put options expiring on December 24th rising as a large buyer force, including SFRZ4 95.00/94.625/94.25 put options, flows in. This is a put option combination with three different strike prices, with 94.625 being the middle strike price. Butterfly options are typically used by traders when they expect the market to stabilize near the middle strike price, providing limited risk and limited potential profit A significant use of indicates that investors may expect the SOFR rate to fluctuate around this level, reflecting a relatively cautious attitude among interest rate traders towards future rate expectations.

Following the buying activity of put option trees at SFRZ4 95.0625/94.875/94.6875, the liquidity at 94.6875 is also very active. This type of tree-like options typically involves buying and selling multiple options, forming a more complex options structure aimed at utilizing different volatilities and price levels, allowing traders to establish protective measures or profit targets at multiple potential market turning points. After the fund flows including the buyers of put spread at SFRU4 94.875/94.75, the exercise of SOFR at 94.875 saw the most severe liquidation this week. Put spreads are usually used to hedge risks or speculate on interest rate declines, and the use of this strategy indicates that the market may hold a cautious attitude towards further rate expectations, especially at this specific exercise price level.

The most active SOFR options exercise price level - net change in SOFR options exercise between the first 5 weeks and the last 5 weeks

SOFR options trading distribution heatmap

The largest number of SOFR options trades expiring in December 2024 are at the 95.00 exercise point, equivalent to a 5% bet on the Fed's benchmark interest rate, where a portion of open contracts can also be seen in the call options for June 2024, indicating a higher open interest volume suggesting market participants anticipate the possibility of SOFR rates rising to 5% or higher by December 2024 - implying the Fed may cut rates by 25-50 basis points, with investors hedging or speculating on the risk of rate increases by purchasing call options.

A significant number of open contracts also appear in the exercise point of 95.50 call options expiring in June 2025, the second largest in terms of quantity. In other SOFR options, there are still considerable amounts of open put options in the exercise ranges of 94.75, 94.875, and 94.9375 for June 2024.

Open interest data for SOFR options - open positions for SOFR options as of December 2024