Short positions in the bond market surge! The August non-farm payroll report is approaching, and a weak non-farm report may trigger aggressive rate cut expectations from the Federal Reserve

The Zhitong Finance APP noted that bearish bets in the U.S. Treasury market are surging, making the employment report to be released on Friday more closely watched. This report could reinforce market expectations for aggressive rate cuts by the Federal Reserve at its September meeting.

JP Morgan's latest Treasury client survey reflects this pessimism. The survey shows that the weekly shift to bearish positions for the week ending September 2 was the largest in nearly five years. Concerns over fiscal issues have pushed the 30-year yield close to the 5% mark, with short positions reaching their highest level since February.

A series of weaker-than-expected economic data had previously led the market to believe that the Federal Reserve would shift to a dovish stance, resulting in lower yields, while the current bets are in stark contrast to that. This shift will be tested when the U.S. employment report is released. If the data significantly falls short of economists' expectations of 75,000 new jobs, it would provide grounds for more aggressive rate cuts and increase pressure on bearish investors to adjust their positions.

Catherine Kaminski, Chief Strategist and Portfolio Manager at AlphaSimplex Group, stated: "If the data is bad enough to break the balance, short-term yields could break down. This could serve as a catalyst indicating that the labor market is in worse shape than expected."

Yield Curve Steepening

Recently, the spread between short-term and long-term Treasury yields has been widening as investors weigh the impact of data showing economic slowdown against fiscal concerns.

The two-year yield, which is more sensitive to Federal Reserve policy expectations, fell to its lowest level since May on Wednesday, as previous U.S. corporate hiring and layoff reports were weaker than expected, leading traders to almost fully price in a 25 basis point rate cut this month.

Although the likelihood of a 50 basis point rate cut in September is considered low, traders in the secured overnight financing rate (SOFR) options market have begun to hedge against this possibility again over the past week.

Sean Simko, Head of Fixed Income Investment Management at SEI Investments, stated that recent bearish positions indicate that some traders believe the recent signs of economic cooling are merely anomalies. "Unless the data is very weak, strong data will push yields up faster than weak data will push yields down."

Meanwhile, long-term yields have continued to rise in recent weeks as investors demand compensation for increased government deficit financing. Unless tariff revenue growth remains stable, the Trump administration's spending and tax cut plans are expected to worsen the U.S. fiscal situation—especially after a federal court ruling last week put this outcome at risk.

A faster pace of rate cuts could alleviate some concerns (at least temporarily), as lower yields would make it easier for the U.S. to service its debt.

However, the key to determining the trajectory of yields in the coming weeks still lies in Friday's data.

Steven Englander, Global Head of G10 Currency Research at Standard Chartered Bank, stated in a report that any data showing less than 40,000 new jobs would push the market to price in a 50 basis point rate cut. "To completely eliminate the possibility of a rate cut, we believe non-farm payroll data must rise to 130,000 or higher, accompanied by positive revisions." The following is an overview of the latest indicators in the interest rate market:

JP Morgan Client Survey

JP Morgan's survey shows that short positions have expanded to the highest level since February 3, increasing by 8 percentage points in the week ending September 2. The net long position is currently at its lowest since February 3.

Most Active SOFR Options

In the past week, the 96.00 strike price has remained active among SOFR options with expirations on September 25, December 25, and March 26. Recent inflows include buyers of SFRU5 96.00/96.125/96.25 call spreads and SFRZ5 96.00/95.875 1x2 put spreads. Additionally, on Friday, there was significant buying of the SFRU5 96.00/96.125 call spread and SFRZ5 95.6875/95.8125/96.00/96.125 call condor options. With the increase in these types of inflow activities, the 96.125 strike price has also become popular over the past week.

SOFR Options Heatmap

Among SOFR options with expirations on September 25, December 25, and March 26, the options with a strike price of 96.125 remain the most active, with a large number of September 25 call options. This is mainly due to the significant positions in the SFRU5 96.125/96.25 call spread, which has been established in recent weeks with a scale of about 350,000 options. There are also a large number of open contracts for options with a strike price of 95.625, primarily due to positions in September 25 put options and December 25 call options. Additionally, there are many open contracts for September 25 put options at a strike price of 95.75.

U.S. Treasury Options Skew

The skew of U.S. Treasury options continues to favor put options at the long end of the curve, while favoring call options at the short end and near end, indicating that traders are paying higher premiums to hedge against the risk of selling long-term bond futures This skew aligns with the demand for steepening options, which remain a crowded position, and the premiums for bond put options are still relatively high compared to other parts of the curve.

CFTC Futures Positions

CFTC data shows that as of the week ending August 26, hedge funds expanded their net short positions in both the front and back ends of the futures market, while asset management companies were bullish on the long positions in the futures market.