Declining Yields Anticipate Further Drop If CPI Shows Dovish Trend

10Y Yields Reach New Multi-week Lows

Following our commentary on the Consumer Price Index (CPI) last week, where we suggested that today's inflation figure may lean towards the dovish side after surpassing estimates for five consecutive months, 10Y yields have hit new multi-week lows. They have slipped to just above 4.40%, down from a peak of 4.65% two weeks ago. This is the lowest point since the last CPI release five weeks ago.

Treasury Option Traders Expecting a Bond Rally

Traders of Treasury options are preparing for a significant bond rally following the release of key inflation data on Wednesday, as reported by Ed Bolingbroke from Bloomberg. European bonds have seen even greater gains, with German and UK benchmark rates both dropping by as much as seven basis points.

Heavy Option Buying Anticipates Drop in US 10-year Yields

Bolingbroke, a strategist at Bloomberg, noted that heavy option buying over the past week has focused on options that would benefit from a drop in US 10-year yields to around 4.3%, the lowest in over a month. One high-risk trade could yield a $15 million windfall by risking just $150,000 if the 10-year benchmark falls even further to 4.25% by May 24.

Open Interest Surges in Options Tied to 110.00 Call Strike

Open interest, or the amount of new positioning, has recently surged in options linked to the so-called 110.00 call strike, which corresponds to a roughly 4.3% 10-year yield level, according to CME data. Buying has been concentrated in the June tenor expiring May 24, capturing this week’s significant economic news including the reports on producer and consumer prices.

Market Concerned About Potential Rapid Easing

Alex Manzara, a derivatives broker at R.J. O’Brien & Associates, noted that there has been a lot of positioning both ways, but most recently there’s been a lot more leaning toward the possibility of easing, and possibly the chance of aggressive easing. He added that the market is clearly worried about something going wrong that could lead to rapid easing.

Expectations of Cooling Data

Samuel Zief, head of global FX strategy at JPMorgan Chase Bank, suggested that there seems to be an expectation that the data will cool from last month and the market does seem to be somewhat set up that way. A recent survey conducted by 22V Research showed that 49% of investors expect the market reaction to the CPI report to be “risk-on” — while only 27% said “risk-off.”

Asset Managers Continue to Add to Long Bets in Futures

Asset managers have continued to add to long bets in futures, increasing bullish positions for a fourth week in a row, according to data from the CFTC.

Bloomberg Commentator Anticipates Extension of Bullish Mood in Treasuries

Ven Ram, a commentator at Bloomberg, agrees with the general setup and suggests that the recent bullish mood in Treasuries is likely to extend if today’s inflation and retail-sales data for April prove to be soft. He also noted that on Tuesday, 10-year bonds made the most of higher-than-forecast PPI numbers. With Chair Jerome Powell describing the data as “mixed,” the markets ran ahead with the idea that components from the data that feed into the Fed’s own PCE gauge weren’t all pointing northward.

Conclusion

Ram concludes that whether or not the rally has endurance is a different matter, but the market’s mood seems to be decidedly one of a bullish tactical bias heading into the all-important data sets today. If CPI comes in soft, it's not just bonds that will rip higher in price, not yield. Chris Weston, head of research at Pepperstone, said that an in-line-with-consensus US core CPI read is discounted and in the price, but that may be enough to promote relief buyers and see the index push higher. He added, “A core CPI read below 0.25% month-on-month and I certainly wouldn’t want to be short.”

Closing Thoughts

It's clear that the market is in a state of anticipation, with many expecting a dovish trend in the CPI. This could have a significant impact on the bond market and the broader financial landscape. What are your thoughts on this? Do you agree with the market's expectations? Feel free to share this article with your friends and engage in a discussion. Don't forget to sign up for the Daily Briefing, which is available every day at 6pm.