The Zhitong Finance App learned that the US CPI inflation data focused on global investors will be released on Wednesday evening Beijing time, and US Treasury bond options traders are preparing for a rise in US bond prices and a sharp drop in US bond yields after the release of key inflation data. This also means that the vast majority of traders are betting that the April US inflation data will cool down significantly, and even that inflation may fall far below market expectations. Foreign exchange traders are also betting that US inflation will ease, so before the CPI is announced, they are betting that the US dollar index will fall. Foreign exchange traders may refocus on the prospects of this year's monetary easing policy and the downward pressure on the US dollar. Furthermore, the collective rise of the three major US stock indices on Tuesday also reflected the stock market's expectations for CPI to cool down.
According to some data, a large number of US bond purchases in the past week focused on options that may benefit from the US 10-year Treasury yield falling to around 4.3%. This is about 15 basis points lower than the current level of this yield, the lowest level in more than a month. One high-risk deal stands out: if the 10-year US Treasury yield falls further to 4.25% before May 24, then traders only need to bet $150,000 and may reap a windfall of $15 million.
Betting on rising prices in the US bond market comes at a time when the bond market has recovered some of its losses after a brutal April. In April, expectations of interest rate cuts were continuously weakened due to excessively strong non-farm payrolls data and inflation exceeding expectations. The price of US bonds of various maturities plummeted across the board, and yields once soared to the highest point in the year. Since then, Federal Reserve Chairman Jerome Powell (Jerome Powell) allayed market concerns by downplaying the need for further interest rate hikes. Combined with an April non-farm payroll report released at the beginning of the month, the cooling of the US labor market may open the door to interest rate cuts, and the number of initial US jobless claims has also increased markedly recently, despite high inflation.
Investors are anxiously awaiting the latest US Consumer Price Index (CPI) data for April, which will be a key factor in determining whether this round of equity and bond gains can continue. On Tuesday, after releasing last month's PPI data report, Powell said in a statement yesterday that the latest PPI data showed “mixed feelings” and indicated that the Fed's next move was unlikely to raise interest rates. The US Treasury bond price rose in response, and the US dollar index fell in response.
Economists expect the US consumer price index (CPI) to increase 0.4% month-on-month in April, which is basically the same as in March. The overall CPI for April is expected to increase 3.4% year on year, slightly lower than the 3.5% increase in the previous month. If the inflation data meets or falls short of expectations, it will reinforce the market's latest expectation that the Federal Reserve will cut interest rates twice this year, for a total of 50 basis points.
Alex Manzara (Alex Manzara), a derivatives broker from R.J. O'Brien & Associates, said: “Both sides have many positions, but recently they are more inclined towards the possibility of policy easing, and it is conceivable that aggressive easing expectations are more likely.” “The market is clearly concerned about the emergence of economic data that could lead to rapid easing.”
According to data from the Chicago Mercantile Exchange, the number of open contracts or new positions linked to the so-called 110.00 call option has recently increased dramatically. This call option is directly linked to the 10-year US Treasury yield of about 4.3%. Buying power is also concentrated on the May 24 treasury bonds due to expire in June. These all reflect this week's major economic news effects, including producer prices and consumer price reports.
Meanwhile, statistics from the US Commodity Futures Trading Commission (CFTC) show that asset management companies have continued to increase their long bets on US bond futures, increasing their bullish positions for four consecutive weeks.
Cautiousness is still evident in some areas of the market. Wall Street bank J.P. Morgan's customer survey on Tuesday showed a slight increase in US Treasury short positions in the cash market, marking a shift from neutral. Notably, the past three consecutive consumer price index (CPI) reports have all unexpectedly risen, leaving US debt bulls puzzled.
Even so, the futures market's bearishness has clearly weakened since the release of the non-farm payrolls report last week. Traders have begun to cancel bearish futures positions related to the Federal Reserve's sensitive Overnight Guaranteed Financing Rate (SOFR), which means continuing to lift hedging deals against potential interest rate hikes and resuming bets on easing policies. New long positions are also appearing in various areas of futures market contracts. The result was a succession of withdrawals from severe pessimism at the end of April, although short positions remained.
Citigroup analyst Ed Acton (Ed Acton) wrote in a report on Tuesday: “Judging from position data, differences in current trading paradigms provide few directional clues.” “Compared to structural shorts that are bearish on US debt, tactical positions are now getting longer and longer.”
Notable options flows include a large bullish “screen” transaction that was completed electronically at a cost or premium of up to $4 million and presented new risks. The same dovish protections were bought again in early Asian trading on Tuesday. Similar to this theme, risk reversal options strategies have also seen significant buying, that is, funding call options by selling put options.
Traders are sending a big signal: yields are declining, and the Fed's easing cycle is coming
The CME “Federal Reserve Watch Tool” shows that interest rate futures traders are betting that the Federal Reserve will cut interest rates for the first time in September, and traders' bets on the Fed's interest rate cut expectations during the year fell from once in April to pessimistic expectations of “no interest rate cut during the year” to around 50 basis points. The “Federal Reserve Watch Tool” shows that traders' expectations for interest rate cuts basically hovered around 25 basis points — 50 basis points, rather than the 150 basis points traders once generally bet on at the beginning of the year.
Fund managers turn to US debt bulls
In the trading week before May 7, that is, after the Federal Reserve announced the policy on May 1 and the employment report released on May 3, fund managers at asset management companies pushed up so-called net term longs for four consecutive weeks. Since then, most of the weekly gains in the US bond market have come from long-term bond futures, with net longs increasing by $2.5 million per basis point. Some hedge funds did the opposite. This week they expanded about 200,000 net short positions on 10-year US Treasury futures. Among them, the net short positions for 5-year US Treasury futures increased by about 7.7 million US dollars per basis point.
J.P. Morgan Chase survey data shows that net bulls have risen to the highest level in three weeks
In the US bond trading market, according to J.P. Morgan Chase's latest survey data on its US Treasury customers, it is shown that the number of short customer positions is clearly declining, and net longings have risen to the highest level in three weeks. The survey covered the week ending May 13.
J.P. Morgan Treasury Bonds All-Client Position Survey - Client Short Numbers Decreased, Net Longs Rise to Highest Level in Three Weeks
Judging from the situation where the premium for put options was too high a month ago, the cost of hedging the sell-off of long-term US bonds continues to drop drastically. The so-called slope at the front end and abdomen of the yield curve continues to be beneficial for paying small premiums to hedge against increases, while the level of inclination of 10-year US bonds is generally neutral. In addition to a series of upward protections for 10-year US Treasury futures that appeared over the past week, there was also an increase in “stifling” capital flows, including the 4x1 sellers that appeared on Monday.
SOFR Options is fully active
The most active SOFR execution price in the past week was 94.6875, thanks to significant recent capital flows, including driven by the recent massive sell-off of 94.6875/94.4375 put option spreads on December 24 and the bullish spread of 94.6875/94.75/94.8125 purchases on June 24, which means traders believe SOFR will not fall below 94.4375 and obtain premium by selling the put option spread. The weekly increase of 94.875 was supported by 94.875 cross-style options on September 24 and the bullish range buying pattern of 94.75/94.8125/94.875 on June 24. This combination strategy involves buying and selling bullish options at different exercise prices at the same time, usually to profit when the price is close to a certain central price.
The most active exercise of SOFR options — net change in SOFR option execution between the first 5 weeks and the next 5 weeks
SOFR options heatmap
SOFR's 96.00 and 97.00 call option open positions on December 24 have risen sharply in the past week. Meanwhile, the SFRZ4 96.00/97.00 call option spread positions have increased sharply to around 185,000. They were bought again on Monday at the 5.5 level of 15,000 to avoid new risks. Currently, the most crowded SOFR option exercise period is December 24, and the exercise price is 95.50. You can see a large number of open positions in the June 24 call option. An option contract on June 24 will expire on June 14, that is, two days after the Federal Reserve's next interest rate policy statement and the release of May CPI data.
SOFR Options Open Positions - SOFR Options ranked in the top 20 open positions as of December 24
Overall, these specific SOFR points and SOFR options contract strategies reflect market participants' expectations for future SOFR trends, and this expectation is closely related to the rising expectations of the Fed's interest rate cut.
For example, selling a put option spread (such as 94.6875/94.4375) indicates that traders think SOFR will not drop drastically, which suggests that the market is confident about the decline in interest rates. The bullish butterfly option portfolio and cross-option purchases indicate that traders expect SOFR to rise or fluctuate greatly. This is related to the market's expectation that the Fed may cut interest rates to deal with the economic slowdown or other risky events.
The increase in bullish option holdings at 96.00 and 97.00 points indicates investors' confidence that SOFR will rise in the future. This usually means that the market expects the Federal Reserve to cut interest rates soon, leading to a decline in the short-term yield curve, which in turn pushes up the SOFR contract.
Traders are ready for the dollar to fall after the release of US inflation data
Some evidence relating to the decline in inflation, such as signs of a cooling in the US labor market and the rise in jobless claims at the beginning of each week, supports the dovish view of Federal Reserve Chairman Jerome Powell. On Tuesday, he stated that raising interest rates is unlikely to be the Fed's next step, and said that interest rate cuts will be considered when confidence in cooling inflation becomes stronger. Under these circumstances, foreign exchange traders may revert back to expectations of this year's monetary easing policy, as well as downward pressure on the US dollar.
According to the data, traders in the foreign exchange market are also betting that US inflation will ease, and that the US dollar index will fall before the CPI is announced. Furthermore, forex traders had been accumulating bearish bets on the US dollar prior to the Consumer Price Index (CPI) release in April. This led to a generally positive index — the one-week risk reversal index, which fell below the benchmark for the first time in two months on Tuesday.
“A cool report may ignite people's hope that the Fed's interest rate cut will return to people's eyes, thereby weakening the dollar's earnings advantage,” said Kyle Chapman (Kyle Chapman), a foreign exchange market analyst from Ballinger & Co. “But Federal Reserve officials may not begin to believe that it is time to relax policy until the data continues to improve for several months.”
For the week ending May 7, CFTC data also shows that traders are withdrawing large bets on the US dollar. Non-commercial speculators, including hedge funds and asset management companies, currently only hold about $24 billion in transactions linked to bets that the US dollar will rise, which is the lowest level since the beginning of April.
Historical data is on time, and the US dollar has been in a slump since the inflation data cooled down. In the past year, when inflation data fell short of expectations three times, the dollar fell significantly at the end of the trading week each time.
Furthermore, the relative premium for euro bullish options (that is, betting that the euro will appreciate next week) has risen to its highest level since February. Bank of America strategists recently said that European investors “have completely removed their long positions on the US dollar since last month,” so the bank is optimistic about the exchange rate of the euro against the US dollar during the release of US inflation data.
The three major US stock indices welcomed the CPI with a sharp rise
On Tuesday, the Nasdaq Composite Index reached a record closing record, and the S&P 500 Index and the Dow Jones Index also closed with gains. The S&P 500 index is getting closer to the all-time high of 5264, which was set in March.
Although the cost of services and goods rose sharply, spurring the US PPI increase more than expected in April, Federal Reserve Chairman Powell insisted that the overall producer price index report was “mixed” due to the downgrade of some previous key data. Reporter Nick Timiraos, who has the title of “Federal Reserve's microphone,” also pointed out that the main impact of PPI data on PCE data, which the Federal Reserve is most concerned about, may be completely offset because lower ticket prices and health care costs may offset the more popular financial services segment.
“Investors now generally expect the inflation rate to decline in April,” said Anthony Saglimbene, an analyst from Ameriprise. “Even if the decline is small, the market is looking for further evidence of a cooling in inflation, proving that the downward trend in inflation is still intact, and importantly, the cooling of inflation is not in the process of being reversed.”
According to a survey conducted by 22V Research, a well-known investment agency on Wall Street, close to 50% of stock market investors expect the market's response to this CPI report will be “Risk On,” or “risk chasing,” while only 27% of investors said it would be “risk-off,” or “risk aversion.”