(Bloomberg) - Bond traders are backing the Federal Reserve into a corner, loading up on long-term bets while at the same time fading the chances that the central bank will extend its rate hiking cycle beyond a 5% peak policy rate this year.
That’s the vibe from futures and options flows seen in the market for short-term interest rate bets known as Secured Overnight Financing Rate — or SOFR — and Treasury futures so far this week, where traders have been establishing new long wagers while at the same time executing dovish hedges.
The market bets that the Fed will pause its hikes before a 5% policy rate is reached runs against the continued message from central bank officials. Federal Reserve Vice Chair Lael Brainard comments Thursday raised further questions on where the central bank may stop its tightening. At a University of Chicago Booth School of Business event, she said that “policy will need to be sufficiently restrictive for some time,” although she avoided pinning down a specific rate target.
Earlier, Boston Fed President Susan Collins said she favors a rate of just above 5% in a speech. On Wednesday, St. Louis Fed President James Bullard had penciled in a forecast for a rate range of 5.25% to 5.5% by the end of this year.
One particular play stood out Thursday, with a position amassed in June 2023 SOFR options, targeting a policy peak between 4.75% to 4.875% and paying a premium of approximately $5.25 million for the hedge. The structure — known as a call condor trade — involved four different strikes, targeting a price range close to what is currently priced into the Fed-dated swaps market and aligning to a couple of additional 25 basis point hikes over the next two policy meetings before a Fed pause.
Wagers also suggest the market is positioning for safety in the Treasury market ahead of a potential recession. Wednesday’s aggressive rally in Treasuries was met with a wave of new long positions in futures, preliminary CME open interest data show, a further reflection of dovish sentiment currently sweeping through the US rates market. In total, approximately $17 million per basis point in cash risk on new positions was established across tenors, equivalent to $20 billion’s worth of the current 10-year benchmark note.
(Updates with Brainard commentary starting in third paragraph.)
By Edward Bolingbroke
