By Gertrude Chavez-Dreyfuss

Higher U.S. 10-Year Treasury Yield Expected

NEW YORK (Reuters) – Investors in the futures options market are betting that the benchmark U.S. 10-year Treasury yield is headed higher, potentially reaching 5% soon. This reflects concerns that the incoming Trump administration’s policies could exacerbate the already bloated fiscal deficit and ignite inflation.

Traders are focused on the crucial 5% threshold in the 10-year note, as crossing this level could negatively impact U.S. stocks. A similar situation occurred in October 2023 when the yield peaked at 5.02%, resulting in the S&P 500 index dropping to a five-month low.

Increased interest rates generally lead to higher borrowing costs for consumers and businesses. The swaptions market also indicates an expectation of rising 10-year rates, albeit less directly than in Treasury futures.

As President-elect Donald Trump approaches his Jan. 20 inauguration, market participants grow anxious about his promises of widespread import tariffs, deemed inflationary, leading many to speculate that Treasuries will decline in value.

“It’s all about the unknowns and the policy fog,” remarked Chip Hughey, managing director of fixed income at Truist Advisory Services in Richmond, Virginia. He emphasized the uncertainty surrounding the extent of tariffs and their inflationary implications.

Trump’s campaign also included promises of tax cuts, which could benefit both consumers and businesses. However, without corresponding spending cuts, these tax cuts could worsen the federal deficit. This could result in increased Treasury debt issuance to cover the spending gap, further driving up interest rates.

Analysts noted a rise in open interest for March contracts of 10-year Treasury futures, particularly in put options with strike prices between 105 and 106. These trades are likely anticipating the 10-year yield reaching between 4.75% and 5.00%.

Higher put purchases compared to call options signal bearish sentiment on 10-year Treasury futures, especially in the March contract with a put-to-call ratio of 1.23. Puts are also more expensive than calls, as indicated by a 1.69 ratio.

“A 10-year yield of 5% isn’t our forecast, but it’s plausible given Trump’s policies and the Federal Reserve possibly pausing its rate cuts,” noted Jan Nevruzi, U.S. rates strategist at TD Securities in New York.

The implied volatility in the swaptions market rose to 24.06 basis points on Thursday from 20.89 bps on Dec. 12, indicating an expectation of increased trading activity short-term. Rate swaps, which generally mirror Treasuries, are often utilized by investors to manage interest rate risks.

It’s important to note that volatility greatly impacts options pricing, and as it rises, there are increasing bets on a higher movement in 10-year swap rates, with current rates at 4.18%.

Thus, the cost of a 25-basis-point strike surged to 23.13 bps on Thursday, from 20.8 bps on Dec. 12.

“The implied volatility on swaptions skews towards higher rates,” explained Amrut Nashikkar, managing director of fixed income strategy at Barclays in New York. He added that a demand exists for protection against higher rates, which indicates a risk premium that investors are prepared to pay.