US Treasury yields rose across the curve on Wednesday, with the 10-year note recovering after earlier falls. Strong US data raised the chance that interest rates stay unchanged through the year. March ADP Employment Change was 62K, above forecasts of 40K, and 4K below February. February Retail Sales rose 0.6% month on month, beating 0.5% forecasts and reversing January’s -0.1%.

Manufacturing Prices Signal Persistence

ISM data showed US manufacturing activity grew in March. The survey also reported factory input prices at their highest level in almost four years. Federal Reserve officials said inflation still needs to move towards the 2% target. Michael Barr said more work is needed, Thomas Barkin said action would be warranted if inflation expectations rise, and Alberto Musalem said policy is “well positioned” near the low end of neutral, while warning supply shocks can raise inflation risks. The US Dollar Index fell 0.27% to 99.58. Five-year breakeven inflation was 2.54% versus 2.57% the day before, while the 10-year rate eased from 2.31% to 2.3%. Markets next watch Initial Jobless Claims and Fed speeches on Thursday. Focus then turns to March Nonfarm Payrolls on Friday, during a US holiday.

Positioning For Higher For Longer

The recent batch of strong economic data suggests we should position for interest rates remaining higher for longer. With both hiring and retail sales beating expectations, the odds of the Federal Reserve cutting rates in the near future have diminished significantly. We believe traders should look at options strategies on Treasury futures that profit from yields either holding steady or creeping higher in the coming weeks. This disconnect between stubborn inflation and the market’s hope for rate cuts will likely lead to increased volatility. The report showing factory input prices at a four-year high is a major warning sign that inflation is not fully defeated, yet the VIX index of volatility remains near its historic lows around 15. Buying call options on the VIX is a relatively cheap hedge against a market overreaction to Friday’s jobs report or other surprises. We see the current weakness in the US Dollar Index as a temporary mispricing and a clear opportunity. Strong US economic performance stands in contrast to sluggish growth in other major economies, a dynamic that historically strengthens the dollar; looking back, we saw this in early 2024 when a similar data pattern sent the DXY up 4% in a single quarter. This suggests traders should consider call options on the dollar, betting on a rebound as the market digests the Fed’s steady stance. The decline in medium-term inflation expectations, with the 10-year breakeven rate falling to 2.3%, shows the market believes the Fed will succeed eventually. However, this creates a conflict with the immediate, real-world data showing persistent price pressures. We can use derivatives to trade this gap, such as positioning in inflation swaps that bet on near-term inflation running hotter than these lowered expectations imply. Create your live VT Markets account and start trading now.

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