Bond Traders Pay $6 Million to Hedge Surprise Inflation Miss

(Bloomberg) -- Bond traders are placing big hedges that the latest read on U.S. price growth will disappoint the growing chorus of inflationistas.

Someone paid $2.8 million on Tuesday for a block trade of three-week call options on 10-year Treasury futures, based on data compiled by Bloomberg and information from traders in Chicago and London. Not long after, a similar block posted with a $3.1 million premium. 

The transactions caught the market’s attention because they target the benchmark 10-year yield falling toward 2.75 percent by expiry at week’s end, from about 2.84 percent now. A sustained rally of that magnitude hasn’t been seen for months (setting aside the haven-buying during last week’s market chaos).

The positions come amid a flurry of trades in eurodollars that began last week and protect against the Federal Reserve taking a more dovish stance than anticipated, such as forgoing a March rate hike. Remarks from Chairman Jerome Powell that the central bank is on the lookout for threats to financial stability only added fuel to those wagers. 

The options activity signals growing unease among traders that the Treasuries rout is running out of steam, even if it’s not carrying through to 10-year yield levels (which have barely budged this week). The January consumer-price report, to be released Wednesday, will be one of the most closely watched in recent memory as investors grapple with renewed volatility. The annual figure is projected to fall from the previous month, and these positions stand to benefit from an even steeper slowdown.

Likely Hedge

The potential payoff may not be the main motivation. That’s because the call spreads on 10-year Treasury futures are likely a hedge, rather than an outright bet, that CPI will miss estimates, according to rates traders familiar with the transactions who asked not to be identified because they’re not authorized to speak publicly.

The transactions are also seen as new positions, given the size of the options trades exceeds the current open interest levels.

That suggests there’s a move afoot to get ahead of the CPI release, and hedge some of the market’s prevailing trades. Large speculators have amassed a record short position in 10-year futures, according to Commodity Futures Trading Commission data through Feb. 6.

©2018 Bloomberg L.P.

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