U.S. Treasury Options Suggest Calm After Rout, Market Maker Says

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Bets in the options market suggest yields won’t go far above current levels, with investors positioned for the 10-year yield to rise modestly to 1.9% in the near term, despite hawkish Federal Reserve minutes last week, said Harm Backx, a trader at Optiver Holding BV in Amsterdam. Bearish bets also lost steam after data on Friday showed a mixed picture of the U.S. jobs market.

While unemployment fell and wage growth beat expectations, payrolls increased by less than half the projection. Yields surged to 1.8% last week — the most since January 2020 — amid a brutal bond market selloff, after the Fed signaled its plan to quicken monetary tightening to combat inflation.

“People are definitely still putting on bearish plays, but not for crazy scenarios,” Backx said in an interview. “The market actually acted very reasonably around the FOMC minutes and not panicky at all. After the payroll figures, we saw less interest from investors in betting on rising yields. Some people are reversing their bearish bets.”

The pace of bond repricing has preoccupied the market because so much is at stake. Although yields remain low by historical standards, a rapid rise could ripple through stocks, credit, housing and commodities. After a torrid start to 2022, a broad index of Treasuries has lost 1.6% this month, more than the 1% decline for all of January 2021. And while strategists surveyed by Bloomberg have a year-end target of 2.04% for the 10-year yield, the pace of increase may soon challenge that figure.

Expectations for the Fed to begin raising interest rates in March — an outlier call just weeks ago — are rising amid signs the central bank is keen to dial back stimulus as the threat of persistently high inflation grows. Analysts are revising their calls, with JPMorgan Chase & Co. (NYSE:JPM), Deutsche Bank AG (NYSE:DB) and Citigroup Inc (NYSE:C). among those moving forward their rate hike calls to March from June previously.

Yet signs from some corners of derivatives markets don’t seem to reflect the jitters in the cash market. The ICE (NYSE:ICE) BofA MOVE Index — which tracks the implied degree of price moves in Treasuries — fell last week. The calmness in the options market may have partly reflected the fact that a lot is already in the price, according to Backx.

“We have seen decent interest in people playing a rise in yields for a few months already, for instance through buying puts and put spreads,” he said. “It tends to increase close to events such as the release of the FOMC minutes.”

To be sure, the recent Treasuries selloff has been more focused on the front end of the market. As a result, the yield curve has flattened, with 10- and 30-year yields lagging shorter-dated peers on the perception that early moves by the Fed may reduce price pressures down the road.

That view in the options market may be challenged this week when the U.S. government publishes its inflation data Wednesday. Consensus expects consumer prices to rise 7.0% for the year through December and 0.4% from a month earlier.

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