Bond market short bets surge! Weak non-farm payrolls in August may trigger aggressive rate cuts by the Federal Reserve.

Notice that the bearish bets in the US Treasury market are increasing, making Friday's upcoming job report more important. The report may strengthen market expectations for the extent of the Federal Reserve's aggressive rate cut at the September meeting. The latest Morgan Stanley survey of Treasury clients reflects this pessimistic sentiment. The survey shows that the weekly change in bearish positions in the week ending September 2nd was the largest in nearly five years. Concerns about the budget pushing the 30-year yield close to the 5% mark have led to the highest level of bearish bets since February. A series of weaker-than-expected economic data had previously led the market to believe that the Federal Reserve would turn dovish and cause yields to fall, but the current bets are completely different. This shift will be tested when the US releases the job report. If the data shows significantly fewer than the expected 75,000 new jobs, it could provide a basis for a more aggressive rate cut and increase pressure on bearish investors to adjust their positions. Catherine Kaminski, Chief Strategist and Portfolio Manager at AlphaSimplex Group, said, "If the data is bad enough to upset the balance, short-term yields could break downward. This could be a catalyst indicating that the labor market conditions are worse than expected." Yield curve steepening The spread between short-term yields and long-term Treasury yields has been widening recently, as investors weigh the impact of slowing economic data and budget concerns. The two-year yield, which is more sensitive to expectations of Federal Reserve policy, fell to its lowest level since May on Wednesday, as weaker-than-expected reports on American hiring and layoffs caused traders to almost completely price in a 25 basis point rate cut this month. Although the possibility of a 50 basis point cut in September is considered small, traders in the overnight Secured Overnight Financing Rate (SOFR) options market have begun hedging against this possibility again in the past week. Sean Simko, Head of Fixed-Income Investment Management at SEI Investments, said that recent bearish positions suggest that some traders believe recent signs of economic cooling are only temporary. "Unless the data is very weak, strong data will push yields higher at a faster rate than weak data will suppress them." Meanwhile, long-term yields have been rising in recent weeks as investors demand more compensation for government deficit financing. Unless tariff revenue growth remains stable, the Trump administration's spending and tax cut plans are expected to worsen the US fiscal situation - a risk exacerbated by a federal court ruling last week. A faster pace of rate cuts may alleviate some concerns (at least temporarily), as lower yields will make it easier for the US to repay its debts. However, the key factor determining the trajectory of yields in the coming weeks is still Friday's data. Steven England, head of G10 currency global research at Standard Chartered Bank, said in a report that any data showing fewer than 40,000 new jobs would shift the market towards pricing in a 50 basis point rate cut. "To completely eliminate the possibility of a rate cut, we believe nonfarm payroll data must rise to 130,000 or higher, accompanied by positive revisions." Here is an overview of the latest indicators in interest rate markets: Morgan Stanley client survey Morgan Stanley's survey shows that bearish positions have expanded to their highest level since February 3rd, increasing by 8 percentage points in the week ending September 2nd. Net long positions are currently at their lowest level since February 3rd. Most active SOFR options In the past week, the 96.00 strike price SOFR options expiring on September 25th, December 25th, and March 26th have remained active, with recent inflows including buyers of SFRU5 96.00/96.125/96.25 call options and SFRZ5 96.00/95.875 1x2 put spread options. Additionally, a significant amount of buying has been seen in the SFRU5 96.00/96.125 call spread and the SFRZ5 95.6875/95.8125/96.00/96.125 call spread options on Friday. As these types of inflows become more active, the 96.125 strike price has also become popular in the past week. SOFR options heatmap Within the SOFR options expiring on September 25th, December 25th, and March 26th, the 96.125 strike price options remain the most active, with a significant amount of September 25th call options, mainly due to the large holding of SFRU5 96.125/96.25 call spread options, which have established a position in recent weeks, with a volume of around 350,000 options. There are also a significant amount of open contracts at the 95.625 strike price, mainly due to the open positions in the September 25th put options and December 25th call options. Additionally, there are a significant number of September 25th call options for 95.75 still open. US Treasury option skew The skew of US Treasury options continues to favor put options in the long end of the curve, while favoring call options in the short end and belly of the curve, indicating that traders are paying a higher premium to hedge against selling risk in long-term bond futures. This skew aligns with the demand for steepening options, which remain a crowded position, with the premium for bond put options still higher relative to other parts of the curve. CFTC futures positions CFTC data shows that hedge funds have expanded their net short positions in both the front and back ends of the futures market, while asset managers have increased their long positions in the front end of the futures market.