Bond Traders Ramp Up Wagers Hedging for 5% Yields as Oil Surges

twg30p555[pn0c6bsqv}d55o_media_dl_2.png Bloomberg, CME

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(Bloomberg) — Traders in the Treasury options market are bracing for long-dated bond yields to surge past 5% as a rally in oil prices continues unabated.

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A flurry of demand has emerged this week for options hedging a bigger bond market selloff over the coming days, pushing yields higher, as Brent crude nears $115 a barrel. A couple of the larger option trades executed this week expire on Thursday, a day after the Federal Reserve meets to set interest rates. 

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The buildup in bearish trades reflects concerns that policymakers, who are expected to leave rates unchanged, could weigh in on the impact of energy prices and supply chain disruptions on inflation, raising risks for tighter monetary policy down the road. The Senate Banking Committee is also expected to hold a vote Wednesday on Kevin Warsh’s nomination to succeed Jerome Powell as Fed Chair, clearing the path for his confirmation by the time Powell’s term expires in mid-May. 

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Among the risks weighing on Treasuries are “sticky inflation, fiscal concerns, and rising global bond yields,” said Collin Martin, head of fixed income research and strategy at Charles Schwab. “Unless the labor market begins showing more signs of cracking, a move up to 4.5% seems more likely than a move down to 4%” in 10-year yields.

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On Monday, a huge position in long-bond options for an $18 million premium was bought. The wager — which stands to benefit if long-dated yields extend through 5% — had already reaped about $8 million in profit by Tuesday as the US 30-year yield rose to 4.97%, the highest level since March 27. A selloff in European bonds saw UK 10-year yields top 5% for the first time since March 27. 

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The recent influx in demand for bearish options bets has elevated the premium on puts relative to calls on long-bond futures, as shown by a sharp drop in the options call-put skew. This is the biggest premium paid to hedge a selloff seen in about a month. 

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“Some of this is just a general need for hedging” based on “a shift in sentiment on the forward inflation front,” said Alex Manzara, a derivatives broker at R.J. O’Brien & Associates. “This idea of higher oil prices has gone from being more of an economic slowdown story to an inflation story,” also reflected in higher yields in UK, German and Japanese bond markets, he said.

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Meanwhile in the cash market, a survey of JPMorgan clients showed an extension of long positions, pushing the net positioning to the most bullish in around a month and raising the risk of long positions getting squeezed. The US 10-year yield was one basis point higher at 4.36% on Wednesday. 

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Here’s a rundown of the latest positioning indicators across the rates market: 

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JPMorgan Treasury Client Survey

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In the week up to April 27, clients’ long positions rose by 4 percentage points, shorts dropped one percentage point while neutral positions declined 4 percentage points. The all-client survey now shows the biggest net long positioning since March 30.