Traders Who Rushed to Safety of Bonds Get Rattled in Reversal

(Bloomberg) -- A recent influx of bullish positioning across the US bond market just got smacked, as comments from a pair of Federal Reserve officials and fresh evidence of sticky inflation increased the odds of interest-rate hikes, sending Treasuries into a tailspin.

Tuesday's selloff rippled throughout the Treasury curve, with traders pricing in a more aggressive Fed tightening path after Governor Christopher Waller said he supported a rate increase and that he'd favor a half-point hike if inflation continued to accelerate. A hotter-than-expected consumer price report added fuel to the shift, as did further hawkish comments from Dallas Fed President Lori Logan.

The rout — which sent two-year US yields soaring by the most in 19 months and briefly pushed 10-year yields back over 5% — upended investors who lately had been flocking to Treasuries or turning less bearish in response to recent market jitters around the AI trade.

Over the last week, asset managers continued to establish long positions in futures across the curve, while covering bearish wagers in the long end, Bank of America Corp. strategists wrote in a Nov. 8 note.

Now, though, with traders increasingly pricing in "frontloading" of Fed tightening into the March meeting next year, the policy-sensitive two-year yield "still has room to get where we were at the end of September," when it peaked just shy of 5%, said Ed Al-Hussainy, portfolio manager at Columbia Threadneedle Investments. It ended Tuesday at 4.73%.

In the cash market, the divergent cross-currents have left some investors struggling for direction. JPMorgan Chase & Co.'s Treasury client survey released Tuesday reveals diminishing levels of conviction, with safe-haven tactical longs and longer-term short positions battling against each other. The poll showed both long and short positions dropping sharply, leaving neutrals at their most elevated in about 12 weeks.

Not all traders were wrong-footed by Tuesday's selloff. In the options market, flows over the past week have started to show signs that traders are unwinding safe-haven hedges. On Monday, a large seller of five-year January 107.00 calls appeared to unwind a bullish hedge set in late October, though at a loss of roughly $3 million.