Traders Pivot as Bond Shorts Drop, Fed Cut Debate Intensifies

Key Takeaway

• Traders cover bearish short positions on US two-year notes, shifting market sentiment to neutral amid Fed rate hike debates.
• Barclays and Citigroup diverge on strategy; Barclays recommends shorting fed funds futures while Citigroup predicts multiple rate cuts.
• JPMorgan survey shows a significant drop in short positions, indicating the largest net long position in three weeks.

Treasury Market's Neutral Stance

Rate traders are currently in a state of limbo, with the Federal Reserve's policy direction for the remainder of the year being a hot topic of debate. The recent soft US jobs data has led investors to dial back their expectations for rate cuts, resulting in a cautious approach towards making significant bets in the Treasury market. This shift to a more neutral positioning is evident from the activity in the futures market, where there has been a notable coverage of bearish positions on shorter-dated notes as yields on US two-year notes retreat from the 5% level. Jerome Powell's recent comments suggesting a pushback on further rate hikes have also played a role in tempering bearish sentiments.

Realigning Strategies Amid Uncertainty

With the Treasury market's playbook wide open for 2024, strategists from major banks are recalibrating their positions. Barclays has recommended shorting fed funds futures and fading the cuts priced into swaps, indicating a skepticism towards the market's dovish repricing. On the other hand, Citigroup maintains its stance on expecting multiple rate cuts within the year. This divergence in strategies underscores the prevailing uncertainty and the wait-and-see approach adopted by many in the market. The unwinding of short positions and the initiation of fresh wagers have led to a surge in futures block activity, particularly in short to medium-dated bonds, highlighting areas most sensitive to central bank policy rates.

Positioning and Sentiment Shifts

The latest client survey from JPMorgan Chase & Co. reveals a significant drop in short positions, boosting the net long position to its highest in three weeks. This change in sentiment is further reflected in the Commodity Futures Trading Commission data, where hedge fund short positions in Treasury futures extended in the week leading up to the Federal Reserve's policy decision on May 1. Conversely, asset managers have significantly extended their net duration long positions, indicating a growing optimism or defensive posture against potential rate cuts. The activity in SOFR options also suggests a strategic positioning for different rate scenarios, with a notable amount of risk being added in specific strikes.

Street Views

• Barclays (Neutral on Fed funds futures):

  "Recommended shorting fed funds futures and fading the amount of cuts priced into swaps."

• Citigroup (Bullish on multiple rate cuts this year):

  "Stood by their call for multiple rate cuts this year."