(Bloomberg) -- Bond traders who’ve been stung by the market’s recent rout are turning more and more bearish ahead of what many expect will be a hawkish tilt by the Federal Reserve.

US Treasuries had their worst performance in seven months in April, with mounting evidence of economic resilience and stubborn inflation causing investors to pare back bets for Fed interest-rate cuts and load up on short bets instead. Traders who began the year positioned for multiple reductions in 2024 are now pricing in just one full quarter-point cut — and some now question whether the central bank will move at all.

Fed speakers including Chair Jerome Powell have signaled in recent weeks that they are willing to hold rates higher for longer if the data continues to come in hot. Investors expect to hear more of the same from the Fed chair on Wednesday. That’s left them in a defensive crouch and wagering on more losses, even after US yields have surged across the board to the highest since November. 

“The short bond trade is back,” said Kathryn Kaminski, chief research strategist and portfolio manager at quant fund AlphaSimplex Group, which established a fresh bearish position in February. “This month in particular you are seeing short bond exposure really working well.” 

Read more: 60,000 Headlines Show Powell’s Hawkish Pivot Has Just Begun

Futures market data for the week leading up to April 23 showed hedge funds building short positions. Commodity trading advisors, or CTAs, have also joined the party, and are now sitting at near “max short duration,” according to Bank of America strategists. Meanwhile in the cash market, JPMorgan Chase & Co.’s latest client survey showed short wagers rising to their biggest levels in three weeks. 

Futures activity focused on shorter-term maturities shows open interest — the amount of positions held by traders — has risen as US 2-year yields have propelled through the 5% level. This points to new bearish positions predominately driving the selloff, rather than profit-taking on bullish bets. 

Despite some signs of profit-taking over Friday’s session following the release of inflation data, shorts still dominate. Traders even added to bearish bets on Tuesday after a higher-than-expected reading for the Fed’s preferred wage gauge.

Read more: Bond Traders Rush to Cover Short Positions After Inflation Data

“We said in February the short signals had sort of returned and we were looking for a real breakout,” AlphaSimplex’s Kaminski said. “This month we saw that breakout move.” 

To be sure, more bouts of short-covering may occur as traders look to lock in profits at lofty yield levels. And with the markets now so bearishly positioned, there’s a chance that Treasuries actually spurt higher on Wednesday, Ian Lyngen, head of US rates strategy at BMO Capital Markets, wrote in a note this week. 

“Should investors be readying for a sell-the-rumor, buy-the-fact dynamic when Powell takes the stage? We suspect so,” Lyngen added. 

Bank of America strategists note, however, that shorter-term maturities may be vulnerable to further losses as traders close out bullish positions that are now “out of the money.”

Here’s a rundown of the latest positioning indicators across the rates market: 

Hedge Funds Re-Establish Shorts

Leveraged accounts added to net short positions in Treasury futures by roughly 100,000 10-year note futures equivalents in the week up to April 23, Commodity Futures Trading Commission data suggests. They took the other side of asset manager positioning shifts, where net longs were extended by almost 200,000 10-year note futures equivalents. Hedge funds extended net short positions in two-year note futures to a fresh record. 

Treasury Clients Add to Shorts and Longs 

JPMorgan’s latest survey showed both short and long positions rising four percentage points on the week, with neutrals dropping eight percentage points. On an outright basis, short positions match the highest since April 8, while long positions are the most since April 15. 

SOFR Options Most Active 

Recent activity in SOFR options has seen the largest build in open interest across 96.00 and 97.00 strikes, largely reflecting continued buying of the SOFR Dec24 96.00/97.00 call spread. Friday’s flow included buying of the upside structure in 15,000 at a level of 5.5 ticks, which took positioning up to around 165,000. The dovish hedge targets a Fed rate as low as 3% by the end of the year. Largest liquidation was seen in the 94.9375 strike over the week, reflecting position unwinds in the SOFR Jun24 calls.

SOFR Options Heat Map

The most crowded SOFR options strike out to the Dec24 tenor remains the 95.00 level, equivalent to a 5% rate, where heavy amounts of open interest remains in the Jun24 calls, which also make up the bulk of outstanding open interest in the 95.50 strike. Positioning is also building in the 96.00 and 97.00 strikes, reflecting demand for SOFR Dec24 96.00/97.00 call spreads. 

Diminishing Premium for Bond Selloff

The premium on options to hedge a selloff in the longer-term Treasuries continues to erode, although it remains expensive compared to the so-called belly and front end, where the premium is close to neutral. Recent flows in the Treasury options market have included downside buyer in the 5-year tenor targeting a yield rise to 4.85% by the end of May, and a $5.5 million short vol position via 10-year June options. 

--With assistance from Liz Capo McCormick.

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