Traders Are Pricing Risk of First Half-Point Fed Hike Since 2000

“It’s a done deal that 10-year Treasuries hit 2% but the selloff is likely to slow for a bit then,” said Damien McColough, head of fixed-income research at Westpac Banking Corp. in Sydney. “Yields will definitely go higher still once the Fed delivers its first hike.”

The jump in Treasury yields is spreading to other markets as investors mull the impact of the Fed tightening faster and further than expected to rein in inflation. Global bonds have come under pressure, the dollar has strengthened and equities have sold off led by high-priced technology shares.

Thirty-year U.S. yields climbed above 2.20% for the first time since June on Wednesday.

Rising Treasury Yields Hit Tech Stocks Again: Wall Street Reacts

Convexity Risk

The rout has taken Treasuries close to levels that could trigger a wave of convexity hedging — a flood of sales when the holders of mortgage-backed securities offload Treasuries to shed U.S. interest-rate risk.

Leading into this week, the latest positioning data from the Commodity Futures Trading Commission showed that hedge funds extended net eurodollar short positions to the most since December 2018, while further out on the curve speculators are now the most net short 10-year note futures since February 2020.

Open interest more than doubled this month for March puts with a 127 strike for the front-dated 10-year Treasury future, making them the most popular option on the security. The contract itself fell to just above the 127 level on Wednesday.

“Probably the most critical security ‘level’ in global markets right now is 127 in UST 10Y Treasury Futures, because the Street is short just a massive amount of downside struck there,” Charlie McElligott, a cross-asset strategist at Nomura Securities, wrote in a note. “If that 127 level goes, the potential for a ‘short gamma/negative convexity’ event grows substantially.”

Yield Expectations

Even those who are skeptical of markets pricing in four 25-basis-point hikes this year see a continued rise in Treasury yields.

“Our house view on rates is: 3 rate hikes in the U.S. in 2022, and 10-year Treasury yield at 2.25% by the end of 2022,” said Homin Lee, macro strategist at Lombard Odier in Hong Kong.

Benchmark Treasury yields are expected to end the year at 2.13%, according to economists surveyed by Bloomberg.

“It’s just a guess but I expect the 10 year yield will rise to around 2.5% in the next few months and maybe 2.75% by year end, depending on how quickly the Fed hikes rates,” said Shane Oliver, head of investment strategy at AMP Capital. “The bond market is starting to realize that secular stagnation is over and inflation will stay higher for longer so yields will head higher.”