Bonds May Be a Dead Trade After CPI

Market update: the U.S. 10-year yield moves up to 4.159%

• U.S. Treasury notes and bonds are weaker following the surprisingly hotter February U.S. inflation report.
• Rate cut odds for 2024 are trending lower, with the odds of a 25-bps rate cut in March only at 1% while the odds of a June cut have dropped to 69.6%.
• Bond volatility remains missing despite the considerable swings over the past week.

The February U.S. inflation report introduced a new reality to the bond market on Tuesday.

Stubborn price pressures are diminishing the likelihood that the Federal Reserve can bring inflation back to +2% y/y in 2024. What should be a friendly base effect period in the inflation data is instead being squandered.

This new reality in the bond market is that traders might need to zero out any lingering rate-cut odds for March and May in the coming weeks. There’s still enough "meat on the bone" there for the zeroing out of those odds to be a short-term headwind for bonds, particularly at the short end of the curve.

But it’s not just March and May. Fed rate cut odds continue to be depleted across the board. The odds of a June cut remain reasonably priced at 69.6%, but some pushback there as well to more of a coin flip could likewise lead to an additional headwind for bonds in the short-term.

That’s not to say that this leads to the conclusion that it’s prudent to trade with a short-delta bias in bonds. It remains the case that any bets on meaningful directional weakness are bets that the Federal Reserve will not cut rates in the first half of 2024.

What it does means is bonds may be set for a period of choppy trading—arguably, they’ve been in a period of choppy trading. While ranges forming are appealing for directionless strategies like short strangles or iron condors, the fact of the matter is that volatility is nowhere to be found (/ZNM4–IV rank: 1.3; /ZBM4–implied volatility (IV) rank: 6.9). The bond trade is effectively dead now.

/ZN U.S. 10-year note price technical analysis: daily chart (October 2023 to March 2024)

The U.S. 10-year Treasury note (/ZNM4) may be carving out a double top against the Feb. 7 and March 8 swing highs near 112’05, or it simply may be resistance in a sideways range that’s been in place for more than a month.

The daily 21-day exponential moving average (one-month moving average) is serving as initial support, but a loss of this level would suggest that the range will prevail rather than the nascent series of higher lows and higher highs over the past two weeks.

Traders may find the 109’25/112’05 consolidation technically sound for deploying range trading strategies like short strangles or iron condors. However, there’s not much juice to be squeezed, on a risk/reward basis, given the diminished volatility environment (IV index: 6.6%; IV rank: 1.3). The trade may be viable, but there may also be better opportunities elsewhere (like in precious metals, which are rate sensitive but have much higher IV ranks).

/ZB US 30-year bond price technical analysis: daily chart (October 2023 to March 2024)

The inverse head and shoulders pattern off the lows called for a measured move higher by the U.S. Treasury 30-year bond (/ZBM4) into 122’03, which was achieved last week when /ZBM4 hit 122’13.

Since then, the uptrend off the February and March swing lows has started to buckle, pushing /ZBM4 back into the middle of the symmetrical triangle that’s been forming since early-December 2023. Much like /ZNM4, there is a discernible range, but is the trade worth it? With duly low volatility (IV index: 12%; IV rank: 6.9), /ZBM4 may be a dead market for the near future (at least until support or resistance are reached).

Christopher Vecchio, CFA, tastylive’s head of futures and forex, has been trading for nearly 20 years. He has consulted with multinational firms on FX hedging and lectured at Duke Law School on FX derivatives. Vecchio searches for high-convexity opportunities at the crossroads of macroeconomics and global politics. He hosts Futures Power Hour Monday-Friday and Let Me Explain on Tuesdays, and co-hosts Overtime, Monday-Thursday. @cvecchiofx

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