Interest rate cut expectations plummet! "Term premium" hovers over the market as U.S. Treasury bulls stage a "mass retreat"

According to Zhitong Finance APP, since last week, global government bond futures traders have been unwinding some large bullish bets on the U.S. Treasury market. Following the unexpectedly strong non-farm payroll report released last week, and with Trump sending letters to various countries threatening further tariffs this week, the inflation outlook faces significant uncertainty, leading to a substantial cooling of global traders' expectations for a Federal Reserve rate cut.

Additionally, the potential expansion of the government budget deficit following the passage of the "Big and Beautiful" bill led by Trump, combined with the turmoil in government spending expectations due to the Japanese Senate elections causing a sharp rise in Japanese long-term government bond yields, has exacerbated the recent upward pressure on U.S. Treasury yields. This is particularly true for the 10-year U.S. Treasury yield, known as the "anchor of global asset pricing," and longer-term U.S. Treasury yields, which may be on a significant upward trajectory, posing a major test for the recently surging global stock markets that have been hitting new highs.

Before the strong non-farm employment data was released last Thursday, traders had built up a large number of long positions in the U.S. Treasury market, generally expecting weak employment data to strengthen the logic for a Federal Reserve rate cut, making the path for a July rate cut clearer. However, this was not the case.

As these dovish expectations were quickly overturned, the risk exposure held by futures traders in U.S. Treasuries—i.e., the number of open contracts—has rapidly declined over the past few trading days. De-leveraging is putting extreme profit pressure on U.S. Treasury bulls, with the changes mainly concentrated in futures contracts linked to 5-year and 10-year U.S. Treasuries, as well as 30-year U.S. Treasuries.

After the non-farm data was released, there was a historically rare large-scale liquidation in 10-year U.S. Treasury futures. Statistics show that just last Thursday, approximately $5 million in risk exposure related to 10-year U.S. Treasury contracts was liquidated for every basis point. This roughly equates to traders cumulatively selling about $7 billion worth of 10-year U.S. Treasuries.

Strong Non-Farm Data, Coupled with the Market's Fear of "Term Premium"

This Tuesday, the global government bond market faced pressure again, mainly due to a large-scale retreat in global demand for long-term sovereign debt, driven by soaring Japanese long-term government bond yields and the potential for the "Big and Beautiful" bill to significantly increase the deficit. The so-called "term premium" has returned to the spotlight—indicating that expectations for rate cuts, having rapidly cooled, are temporarily unable to dominate market trading logic. The market is beginning to worry about the spillover effects of rising Japanese long-term government bond yields, as governments overly rely on long-term bond financing, leading them to demand higher long-term government bond yields.

The 10-year U.S. Treasury term premium, which measures investors' concerns about Washington's future massive borrowing scale, is currently hovering at its highest level since 2014.

The massive issuance of government debt during the Biden administration has significantly increased the scale of U.S. Treasuries to $36 trillion in just a few years, which has also led to soaring budget deficits and record high interest payments on U.S. debt. With the passage of the "Big and Beautiful" bill, which will lead to even larger deficits, U.S. Treasury yields across all maturities may continue to soar in 2025, especially for longer-term U.S. Treasury yields (10 years and above) It may continue to break through multiple historical highs that have lasted for decades under the "term premium" push.

The so-called term premium refers to the extra yield that investors require for holding long-term bonds due to the associated risks. Some economists believe that during the Trump 2.0 era, government bonds and budget deficits will be much higher than official forecasts, mainly because the new government led by Trump focuses on an economic growth and protectionism framework of "domestic tax cuts + external tariffs," combined with an increasingly large budget deficit, interest on U.S. debt, and military defense spending. The U.S. Treasury's bond issuance may be forced to expand even more than the Biden administration's excessive spending during the "Trump 2.0 era." Additionally, under "de-globalization," China and Japan may significantly reduce their holdings of U.S. debt, making the "term premium" inevitably higher than previous data.

"The strong non-farm payroll data has led the market to reduce the expectation of a rate cut in July to almost zero. Recently, U.S. Treasury bulls are undoubtedly under pressure, prompting liquidation that has driven prices lower," wrote Citigroup strategist David Bieber in a report.

However, he added that as yields rise, the tactical positions in U.S. Treasuries "remain biased towards bullish," but recent bullish bets are now in significant loss. Statistics released by the Commodity Futures Trading Commission (CFTC) on Monday showed that asset management firms have increased their bullish positions in 5-year and 10-year U.S. Treasury futures, currently at record bullish levels.

With the market-dreaded "term premium" shadow lingering over the Treasury market, the upcoming issuance of $39 billion in 10-year U.S. Treasuries and $22 billion in 30-year U.S. Treasuries on Wednesday and Thursday may further squeeze the U.S. Treasury bulls concentrated in the long-duration area, especially if signs of weak demand appear. Short-term U.S. Treasuries remain favored by the market, reflecting a severe divergence in U.S. Treasury yield patterns brought about by the "term premium." It is understood that the auction of $58 billion in 3-year Treasuries on Tuesday performed more robustly than expected.

Here is the latest overview of positions in the U.S. Treasury and interest rate markets:

JPMorgan U.S. Treasury Client Survey

JPMorgan's survey shows that in the week ending July 7, clients in the cash market increased both long and short positions simultaneously. The net long position in the U.S. Treasury market is at its highest since June 16, although direct short positions have reached their highest level in a month.

JPMorgan U.S. Treasury All Client Position Survey - Clients' direct long and short positions have both increased this week

Most Active SOFR Options

In the SOFR options market before the March 2026 expiration, a single trade dominated the dramatic changes in open contracts this week, namely a large purchase of put spreads at 96.375/96.25/95.875/95.75 for December 2025. This position reflects the market's bet that the Federal Reserve may maintain the benchmark interest rate unchanged this year, which contradicts the current market expectation of two rate cuts totaling 50 basis points in the next four FOMC meetings Another large buyer has purchased a call spread of 95.875/95.9375/96.00/96.125 for September 2025, exacerbating the new position changes that emerged over the past week.

Most Active SOFR Options Strike Prices - Ranked by Weekly Net Changes for the Top Five and Bottom Five SOFR Options Strike Prices

The chart shows a surge in trading volume for the "put condor" contracts at 96.375, 96.25, 95.875, and 95.75 (significant buying of put spreads), which is a strategy that tends to favor a conservative interest rate outlook, anticipating that the Federal Reserve will maintain its no-rate-cut stance before the end of the year. This SOFR combination will yield the maximum benefit after the FOMC rate meeting, but the chart indicates that the market is clearly betting that "the Federal Reserve will maintain a policy pause," which is in stark contrast to the market's previous bet on a 50 basis point rate cut path.

The SOFR options market is beginning to show signs of heavy condor strategies, which is a financial expression of the market's expectation for the Federal Reserve to "stay put." In other words, some options buyers are positioning themselves against rate cuts, betting on a tough policy stance. This expectation is similar to Morgan Stanley's rate cut outlook, where the economists recently predicted that the Federal Reserve would not choose to cut rates in 2025 and maintained the expectation that core PCE inflation would rise to 3.5% by the end of the year, forecasting that Trump's tough immigration policies would keep labor growth steady, thereby maintaining a tight labor market.

The U.S. Treasury market had previously accumulated a large number of long positions; however, the non-farm and macro data contradicted the rate cut expectations, and the surge in Japanese long-term government bond yields, along with uncertainties in tariff policies and the budget deficit expansion path brought about by the "Big and Beautiful" Act, have all contributed to the resurgence of "term premium"—continuously reaching the highest levels since 2014, with the 10-year U.S. Treasury yield quickly climbing upwards. The configuration of the SOFR options market and the yield trends also show consistent signs—betting on the bursting of the rate cut expectation bubble and a rebound in yields.

SOFR Options Heatmap

The 95.625 strike price is the most popular among options for September 2025, December 2025, and March 2026, including a large number of put options for September and December 2025. Other active strike prices include 95.75 and 95.875, with put options for September 2025 being particularly prominent. Recent capital flows in SOFR have included protective bets on both the upside and downside following the strong non-farm data release.

SOFR Options Open Interest - The Top 20 Most Active Options Strike Prices for September 2025, December 2025, and March 2026 The chart highlights "Dec25 96.375/96.25/95.875/95.75 put condor" — indicating a heavy buying of the Dec25 related put option combination, aiming to lock in the range of 95.75–96.375. This suggests that some traders expect the Federal Reserve will not choose to cut interest rates by the end of the year, with implied expectations close to zero for easing. The heatmap shows that most positions are concentrated at the strike prices of 95.625, 95.75, and 95.875, where there are significant amounts of put options, indicating that some traders are actively positioning for downside hedges, locking in that rates will not decline significantly. These concentrated positions clearly show that some traders have high confidence in the "Federal Reserve maintaining its policy unchanged."

U.S. Treasury Options Skew

After the U.S. Treasury market weakened last Thursday and this Monday, the skew of long-term bond futures options turned bearish, indicating that traders are once again willing to pay a premium to hedge against bond sell-offs rather than increases. In the U.S. Treasury options market, recent liquidity trends include an $8 million short volatility trade (achieved through selling straddles) and a $32 million premium trade, betting that a larger rebound trend may soon emerge in the bond market.

CFTC Futures Positions

Before the release of last week's non-farm payroll data, traditional asset management institutions rapidly increased their long positions in U.S. Treasury futures, especially reaching a historical high net long position in 5-year and 10-year Treasury contracts, including ultra-long 10-year Treasury futures, indicating that rising yields are prompting traditional asset managers to gradually increase their allocation to U.S. Treasury assets.

According to CFTC data as of July 1, asset managers increased their net duration long positions equivalent to 10-year Treasury futures by approximately 582,000 contracts that week, marking the largest single-week increase since April 2024. In contrast, hedge funds have taken an aggressive bearish stance on U.S. Treasuries, adding about 148,000 contracts equivalent to net duration short positions in 10-year U.S. Treasury futures.

The rise of the "anchor" for global asset pricing is unfavorable for the valuation expansion of stocks and other risk assets

Since the beginning of this year, U.S. Treasury investors have generally felt pressure due to inflation concerns triggered by the global trade war initiated by the Trump administration and the increasingly expanding debt burden in the U.S Especially in the U.S. Treasury market, the expectation of a significant expansion of the U.S. government's budget deficit and increasingly pessimistic expectations for the growing U.S. Treasury yields have led bond traders to demand higher "term premiums." As a result, the yield on the 10-year U.S. Treasury has continued to hover above 4.5% this year, recently moving from a relatively low point of 4.2% towards a 4.5% yield, which exerts tremendous pressure on the valuations of risk assets such as stocks. If the yield on the 10-year U.S. Treasury heads towards 4.5% or even 5%, it will undoubtedly be a significant pressure force on the recently record-high MSCI global stock market benchmark index and the S&P 500 index, especially for high-valuation tech stocks closely related to artificial intelligence.

From a theoretical perspective, the yield on the 10-year U.S. Treasury corresponds to the risk-free rate indicator r in the important valuation model of the stock market—DCF valuation model. When other indicators (especially the cash flow expectations on the numerator side) have not changed significantly—such as during earnings season, where the numerator is in a vacuum due to a lack of positive catalysts—if the denominator level is higher or continues to operate at historical highs, the valuations of tech stocks, high-yield corporate bonds, and risk assets like cryptocurrencies, which are at historical high valuations, face the risk of collapse