Confident of a Fed rate hike tonight! Extreme bearish sentiment emerges in the US Treasury market.

Short positions in the U.S. Treasury market have accumulated to levels rarely seen in recent years, with traders betting that the Federal Reserve will restart its rate hike cycle tonight.

The yield on the 10-year U.S. Treasury note rose to its highest level since 2007 on Tuesday, while the 2-year yield also hit its highest level since 2024. Market pricing indicates that Wall Street expects a greater than 90% probability of a 25-basis-point rate hike at the Federal Reserve's meeting tonight. The interest rate swap market reflects that the Fed will tighten by approximately 50 basis points over the remainder of the year.

Citi strategist David Bieber stated, "Short positions have accumulated rapidly over the past week as the market chases rising yields," adding that the current short positions are "tactically extreme."

Bank of America strategists Meghan Swiber and Eleanor Xiao also pointed out, "Ahead of the Fed meeting, positioning remained consistently short, with short positions accumulating across the entire yield curve. Asset managers mostly reduced their long positions or increased their short positions, and there was little indication that funds were buying duration assets at low levels."

Short positions are accumulating rapidly, marking the fastest growth rate in recent years.

Multiple market indicators suggest that bond traders are increasing their short positions at an unprecedented pace.

According to JPMorgan's Treasury client survey, in the week ending September 14, client short positions jumped 10 percentage points, primarily driven by a shift in neutral positions—which fell 8 percentage points over the same period. The full client survey results show that net long positions have fallen to their lowest level in approximately four months, and the pace of short-position accumulation over the past week was the fastest since early 2025.

Meanwhile, CME Group data shows that short positions in Treasury futures increased both before and after last week's stronger-than-expected inflation data. In the federal funds futures market, a large short position means that for every basis point movement in the underlying contract, the position will have a profit or loss of $1.9 million.

Oil prices, inflation, and fiscal pressures are all increasing the certainty of interest rate hikes.

The market's high expectations for interest rate hikes are driven by a combination of macroeconomic factors.

The surge in oil prices triggered by the war, signs of a rebound in inflation, and concerns about the fiscal deficit have all reinforced market expectations that the Federal Reserve must act. Jason Thomas, global head of research and investment strategy at The Carlyle Group, told Bloomberg that the Fed is facing "enormous pressure" to implement a 25-basis-point rate hike.

"People have been hurt by the accumulated price increases," he said. "Living standards have declined, and I think the Federal Reserve must take its price stability mandate seriously."

Thomas also warned that if the Federal Reserve fails to raise interest rates, or fails to provide clear guidance on the subsequent path after raising rates, it could prompt traders to demand higher yields on long-term bonds to hedge against inflation risks, while simultaneously suppressing short-term yields that are closely linked to the direction of monetary policy.

A minority of traders are betting on "holding steady," but this remains a fringe view.

Despite the high degree of consensus among mainstream expectations, there are still hedging operations in the market that anticipate the Federal Reserve keeping interest rates unchanged.

On Tuesday, the short-term interest rate options market saw unusual activity, with a significant increase in trading volume for October and November call options linked to the Secured Overnight Financing Rate (SOFR). The buying of these low-priced options suggests that some traders are setting up protections in case the Federal Reserve does not raise interest rates.

However, this view remains in the minority. Looking at the broader SOFR options market, the mainstream pricing direction is still that futures contracts will further factor in downside risk premiums in the coming months. Treasury option skew data also confirms this assessment—the put option premium for long-term contracts continues to be higher than that for call options, reflecting that traders' hedging costs for further increases in long-term yields remain high.

A massive amount of short volatility trading has emerged in the SOFR options market.

A recent, unusually large short volatility trade occurred in the SOFR options market, further revealing a convergence in market judgments regarding the interest rate path.

According to Bloomberg data, a large amount of new risk exposure has accumulated around the strike price of 95.4375 in SOFR December 2026, March 2027, and June 2027 options, mainly from a large short volatility structure constructed by selling June 2027 straddle options.

Over the two trading days last Friday and Monday, approximately 80,000 contracts of this straddle option were traded, with a total premium exceeding US$100 million—of which about 30,000 new contracts were opened on Friday and about 50,000 contracts were sold on Monday. The option will expire on June 11 next year.

In addition, following the release of the CPI data, the market added a number of protective positions against downside risks, including SFRZ6 breakdown put spreads and bearish hawkish combinations, indicating that traders expect the Federal Reserve to continue accumulating interest rate premiums in the coming months.

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