Bond Bears Go Big Ahead of June Fed Meeting

IEF is heavily shorted, even though it rallied after the FOMC's last rate hike

Editor-in-Chief
Jun 12, 2018 at 8:34 AM
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With just days to go until the next Federal Open Market Committee (FOMC) meeting, fed funds futures are pricing in a 91% chance of a 25-basis point interest rate hike (per CME Group), as of this writing. Since this policy-tightening move is all but assured as far as investors are concerned, traders have been busily targeting bond funds for bearish plays.

Our focus this week is on the iShares 7-10 Year Treasury Bond ETF (IEF), which is designed to track the performance of intermediate-term U.S. Treasuries. The exchange-traded fund (ETF) has pulled back considerably from its 2017 closing high of $108.72, though IEF has lately been mounting a bit of a challenge to resistance at its 80-day moving average -- a former layer of support that has been surmounted just three times on a daily closing basis since late September (with those three closes occurring consecutively from Tuesday, May 29 through Thursday, May 31).

Given IEF's established downtrend and the strong likelihood of another imminent rate hike, it's no surprise to find that traders are betting on more downside -- and in massive numbers. Short interest on IEF more than doubled in the past two reporting periods, and the 8.03 million shares currently sold short represents a new high-water mark for these bearish bets.

Meanwhile, put open interest on the intermediate-term bond fund has been hitting its own fresh highs. Trade-Alert calculates 356,033 puts in open interest on IEF -- easily outnumbering the 242,729 calls that have been opened, and a figure that arrives in the 99th percentile of its annual range. And in fact, the current reigning high for IEF put open interest, at 356,192 contracts, was established as recently as last Thursday.

To put these numbers in context, consider the backdrop on IEF ahead of the last Fed rate hike on March 21 (which was widely anticipated). At the time, short interest was less than half what it is now, at fewer than 4 million shares sold short. Likewise, put open interest on IEF checked in at about 246,400 contracts -- nearly one-third below current levels.

However, note on the accompanying chart (per the red arrow) that IEF actually closed higher the day of that March 21 rate hike, and then gapped higher in the following session. The positive momentum eventually carried IEF above its 50-day moving average, albeit briefly -- suggesting that in the case of intermediate-term bonds, traders sold the expectations for a March rate hike, and then bought the news.

If we see a repeat this time around, with IEF rallying in response to an expected June rate hike, it should set up an interesting expiration-week situation. The front-month 102 strike is directly overhead, and speculators have focused their efforts fairly intensely on this price point, which is home to 41,233 open calls and 32,035 open puts. As such, another post-rate hike pop from IEF could set up a scramble in the options pits as June expiration draws closer.

ief daily chart ahead of june fed meeting


Subscribers to Bernie Schaeffer's Chart of the Week received this commentary on Sunday, June 10.


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