Non-farm data causes a stir: US bond yield curve trading heats up, spreads widen to four-year high.

After noticing an unexpected rise in the unemployment rate in November, which added uncertainty to the mixed signals surrounding the outlook of the US economy, bond traders made a big bet on a popular strategy: favoring short-term US bonds over long-term US bonds. On Tuesday, the spread between the 2-year and 30-year US bond yields widened to the largest level in over four years, reflecting market expectations that the Federal Reserve will cut interest rates at least twice next year, amidst stubborn inflation and strong economic growth. All of this has fueled the so-called "steepening curve" trade. This trade aims to bet that the yield spread between short-term and long-term debt will continue to widen. Despite relatively high inflation, the trade has garnered attention since the Fed resumed interest rate cuts in September. On Thursday, delayed consumer price data from November will provide further examination of this trade. US bond futures also highlight that positions betting on a steepening yield curve are accumulating rapidly. Changes in open interest data for futures contracts suggest new long positions at the short end of the curve. Meanwhile, a premium position of $15 million targeting deeper sales of long-term US bonds surfaced on Tuesday. Kevin Flanagan, head of fixed income strategy at WisdomTree, said, "The 2-year yield is anchored by the Fed and rate cut expectations, while the back end of the curve is reacting to broader issues that the economy is not on the brink of a recession, and there is persistent inflation." He stated that this has locked the 10-year yield in a range of 4% to 4.5%. On Tuesday, after initial data-induced volatility, yields overall fell, with the 10-year yield trading around 4.15%. In the futures market, a large spread trade during Monday's trading session, with a risk weighting of $60,000 per basis point between the 2-year and 30-year yields, was in line with the widening trend of the spread. When this trade was executed, the spread traded at around 132 basis points. On Tuesday, the spread widened to around 137 basis points, indicating a profit of $3 million within a day. Here are the latest positioning indicators in the interest rate markets: JPMorgan survey As of the week ending December 15th, investors' direct long positions increased by 6 percentage points, shifting from neutral to long, while direct short positions remained unchanged. New dovish SOFR options In the SOFR options market, there has been a significant increase in risk exposure over the past week in options expiring on March 26, June 26, and September 26, particularly at multiple strike prices for call and put options expiring on March 26. Traders are looking to hedge against dovish and hawkish policy scenarios that may arise around the Fed's next two meetings next year. A large increase in risk exposure is reflected in the significant accumulation of call options with strike prices at 96.375/96.50/96.625/96.75 expiring on March 26. At the same time, to hedge against downside risks, put options expiring on March 26 with strike prices at 96.375/96.3125/96.1875, as well as similarly popular put options expiring on March 26 with strike prices of 96.50/96.4375/96.375/96.3125 have also been bought. In options expiring on March 26, June 26, and September 26, the highest open interest is at the 96.50 strike price, with a significant amount of open contracts for both call and put options expiring on March 26. The 96.375 strike price has the second highest open interest, with a large volume of put options expiring on March 26. Additionally, the open interest for call options with strike prices at 97.00 and 96.75 expiring on June 26 is also considerable. SOFR options open interest Top ten strike prices for options expiring in March 2026, June 2026, and September 2026 Treasury options premium In the past week, the premium used to hedge US Treasury risk has continued to favor put options premium, with put options premium exceeding call options premium in long-term bond contracts, resulting in a delta value of 25 days of 1-month contracts dropping to the lowest level since August. This trend reflects investors' continued demand for steepening the yield curve in treasury bonds, as they expect the performance of the long-term yield curve to be inferior to the short-term and medium-term yield curves. On Tuesday, the steepness of the yield curve from the 2-year to the 30-year Treasury bond reached its highest level since November 2021, surpassing 137 basis points.