(Bloomberg) -- Traders are leaning toward further gains in the world’s biggest bond market, after a rally that got a major boost from short-covering by hedge funds this month.

That’s the read from Citigroup Inc.’s latest modeling as well as Treasuries positioning data from the Commodity Futures Trading Commission. The scramble to dump short positions helped drive two-year yields down around 100 basis points from a March 8 peak above 5% as banking-sector turmoil led traders to exit bets on Federal Reserve tightening. 

Now, Citigroup strategists say positioning has turned bullish in some parts of the yield curve, as traders assess the Fed’s immediate path with risks to the financial system lingering and officials still signaling an intent to fight elevated inflation. 

“Fast- and medium-term positioning has flipped long as yields squeeze lower driven by short covering (capitulation),” Citigroup strategists Ed Acton and Bill O’Donnell said in a note Tuesday, referencing the bank’s positioning model. 

Swaps traders see it as a tossup as to whether the Fed tightens by a quarter-point at its next gathering in May, rather than pause its year-old campaign of rate increases. Just a few weeks ago, traders anticipated several more quarter-point hikes on top of the one the Fed delivered last week.

Two-year yields were little changed around 4.1% in Asia trading Wednesday.

The following is a rundown of how positioning stands in various parts of the rates markets:

Hedge Funds Dump Shorts

With speculators trimming bets on Fed tightening, they continued to unravel short positions in two-year note futures in the week through March 21, according to the latest CFTC data. In total, around $2.7m/DV01 of net cash risk was unwound, after the position had been at a record. 

The data show a larger unwind of short bets among speculators in Secured Overnight Financing Rate futures. In this market, the net short position shrank by $6.2m/DV01, also from a record. 

Skew Remains Positive

In a sign that traders are paying up to hedge against further declines in yields, the options skew on 10-year note futures has remained positive. That shows calls are in favor as 10-year Treasury rates oscillate around 3.5%, down from 4% several weeks ago. The skew is off its most extreme levels reached two weeks ago, indicating traders are paying a slightly lower premium to protect against a Treasuries rally. 

Bullish Play Still Active

In June 10-year Treasury options, open interest remains elevated in 112.00 and 114.00 call strikes, suggesting outstanding risk remains in a $60 million bullish play from March 14 via a 10-year Jun23 112.00/114.00 call spread wager.


SOFR Heat Map

Open interest in options tied to SOFR remains elevated across a range of strikes between 94.25 and 95.50 out to Dec23 tenors. Recent stand-out flows have included 65,000 SOFR Jun23 95.75/95.50/95.25/95.00 put condor, and 24,000 SOFR Jun23 95.1875/95.4375/95.6875 call fly.




(Updates with Wednesday trading)

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