Bond Traders Take Cautious Stance Ahead of Key Inflation Data

Bond market traders are adopting a more neutral stance ahead of Wednesday's release of US consumer price index (CPI) data, a crucial factor in shaping expectations for future Federal Reserve interest rate cuts, reports Bloomberg. This shift follows a three-week rally in US government debt.

JPMorgan Chase & Co.'s weekly client survey, released Tuesday, revealed that client sentiment on Treasuries has turned neutral, marking a reversal from the strongest long bias seen earlier this year. The upcoming CPI report is particularly significant, as Fed Governor Christopher Waller recently suggested that data preceding the December 17-18 FOMC meeting could influence the decision on whether to hold rates steady or implement another cut.

While swaps markets currently price in an approximately 80% probability of a quarter-point rate cut this month, the resilience of the US economy and speculation that President-elect Donald Trump's policies will accelerate inflation have fueled bets on a potential pause in rate cuts. Beyond December, markets are anticipating roughly two additional quarter-point reductions by the end of next year.

The market for fed funds futures, closely tracking Fed rate expectations, also indicates a reduction in bets on a December rate cut. Open interest has declined in both January and February futures contracts, suggesting investors are unwinding long positions.

JPMorgan's Treasury client survey for the week ending December 9 shows a shift to a neutral stance from a long position in Treasuries. Bullish positioning decreased by 6 percentage points, with neutral positions increasing by the same amount. Outright long positions have returned to levels seen a couple of weeks prior, while neutral positions are at their highest point in two weeks.

The cost of hedging bond market moves using options has remained relatively balanced this past week, with most tenors trending near neutral. This signifies that the cost of protecting against both rallies and selloffs is roughly equal. In contrast to a recent surge in bearish hedges, notable recent flows in Treasury options have targeted lower yields.

Across SOFR options, there's been a mix of new positioning and liquidations. New positioning has seen the largest increases in the 95.9375 and 96.125 strikes. Heavy liquidation was observed in the 95.625 strike.

In CFTC futures positioning, asset managers increased net-long duration positions in Treasury futures, while hedge funds reduced net duration shorts. In SOFR futures, both investor types reduced net long positions, resulting in a net short position for the first time since July.