Options market pegs 10-year US Treasury yield to reach 5% in near term By Reuters
Written by Gertrude Chavez-Dreyfuss
NEW YORK (Reuters) – Investors in the futures market are betting that the rate will rise to 5% in the near term, reflecting concerns that the Trump administration’s upcoming policies will increase the already bloated deficit and revive inflation.
Traders are watching that key 5% rate on the 10-year note, which, if hit, could be bad news for US stocks, as it was in October 2023 when the 10-year yield rose to 5.02%. That coincided with the rate falling to a five-month low.
Higher interest rates often mean higher borrowing costs for consumers and businesses.
In swaps, or options on interest rate swaps, the market is also pointing to 10-year highs, although not as directly as those in Treasury futures.
As President-elect Donald Trump approaches his inauguration on January 20, market participants have become increasingly concerned about his promise to impose tariffs on imports, a move widely viewed as inflationary, as they bet the Treasury will sell, pushing yields higher.
“It’s all about the unknown and the policy fog,” said Chip Hughey, managing director of fixed income at Truist Advisory Services in Richmond, Virginia. “That uncertainty is about the amount of the tax and what that might ultimately mean for inflation.”
Tax cuts are also one of Trump’s campaign promises, which should benefit consumers and businesses in general. But if tax cuts are not supported by spending cuts, they will likely increase the federal deficit. That means more Treasury debt issuance floods the market to manage the spending gap, which raises interest rates.
Analysts said open interest, the number of outstanding positions held by traders, was building in the March contract for 10-year Treasury futures put options, with strikes at price levels of 105 to 106, according to traders, citing their data on Thursday. Those strikes look for a 10-year yield between 4.75% and 5.00%.
Treasury put options are often used to hedge against falling bond prices resulting in higher implied returns.
The US 10-year yield was little changed on Thursday at 4.689%, after hitting an eight-month high of 4.73% on Wednesday.
BEARISH SENTIMENT
More positions have been purchased than call options that can gain value when futures prices fall and implied yields rise. That’s especially the case for the March contract where the put-to-call ratio of 1.23 suggests bearish sentiment for the future of the 10-year Treasury note.
Premiums, or the contract price of options, are also more expensive than those of calls, with a ratio of 1.69 in favor of puts.
“A 10-year yield of 5% is not our forecast, but I don’t think it’s out of the realm of possibility that we could get there,” said Jan Nevruzi, US strategist at TD Securities in New York, citing Trump’s policies. and the Federal Reserve indicating that it may halt its rate-cutting cycle.
“With the highs changing, we’ve seen options trade close to 5% yield. It’s certainly a psychological barrier that people will look to trade.”
In the derivatives market, the implied volatility of one-month options on 10-year exchange rates rose to 24.06 basis points (bps) on Thursday, from 20.89 bps on Dec. 12, reflecting expectations of increased activity at this maturity in the short term. Swap rates, usually tracked by the Treasury, measure the cost of exchanging a fixed-rate currency for a floating-rate currency, or vice versa. They are used by investors to hedge interest rate risk.
Volatility is a key input to an option’s value. The higher the volatility, the greater the uncertainty in a given period.
As volatility rises, there are bets rising on 10-year swap rates in a month by paying so-called “payer strikes” of about 25 bps more on 10-year options, analysts said. It’s a gamble that 10-year exchange rates will be 25 bps a month, and it’s likely because the 10-year Treasury yield will likely rise again. The current 10-year exchange rate is 4.18%.
The cost of that 25 basis point strike rose to 23.13 bps on Thursday, from 20.8 bps on Dec. 12, when they went down for about five months.
“The implied volatility in volatility is skewed to higher levels,” said Amrut Nashikkar, managing director of fixed income strategy at. Barclays (LON:) New York. “What that tells you is that there is a need to hedge against higher rates and there is a risk premium that people are willing to pay to buy protection against higher rates.”
