"Long on US Treasuries" doves celebrate: Mild inflation helps boost SOFR options betting on a 90% probability of a rate cut in September.

A mild US inflation report is strengthening traders' positions, betting that the Federal Reserve will soon cut interest rates. Some believe that the possibility of a large rate cut is increasing. In recent weeks, investors have been betting that mild inflation will lead the Federal Reserve to lower borrowing costs in the coming months through swaps, options, and direct purchases of US bonds. This viewpoint was preliminarily validated on Tuesday. Data shows that the US CPI increased by 0.2% in July from the previous month, in line with estimates and below the previous value of 0.3%; the CPI increased by 2.7% year-on-year in July, in line with estimates, below the previous value of 2.7%. The core CPI in July increased by 0.3% from the previous month, in line with estimates and above the previous value of 0.2%; the core CPI increased by 3.1% year-on-year in July, in line with estimates, above the previous value of 2.9%. After the release of the US CPI data for July, short-term US bond yields fell, and swap traders raised the probability of a Fed rate cut in September to 90%. It is worth noting that traders' bets on the Fed cutting rates by more than 25 basis points in September have also gained more attention. They have added about $2 million in option premiums to positions tied to the Secured Overnight Financing Rate (SOFR), which will profit in the scenario of a rate cut of more than 25 basis points in September. Rick Rieder, Chief Investment Officer of BlackRock's Global Fixed Income Department, said: "Today's inflation report is slightly higher than levels in recent months but lower than many have feared. Therefore, we expect the Fed to start cutting rates in September, and a cut of 50 basis points is also reasonable." However, Tuesday's report did not completely relax the Fed. While the moderate increase in commodity prices eased market concerns about tariff-driven price pressures, the core inflation rate in the US in July hit its highest level since the beginning of the year. With more than a month to go before the Fed meeting on September 16-17, bond bulls will need to go through another important inflation report and key employment data. Chief Economist at New Century Advisors, Claudia Sahm, said: "A rate cut in September is not set in stone. We don't have concrete data to prove this." However, the market's focus is still on bets on the Fed's dovish stance. According to media calculations, options trading linked to the September SOFR contract (with premiums around $5 million) could yield up to $40 million in returns if the market prices in a 50 basis point rate cut that month. Meanwhile, in the spot market, investors had reduced their long positions in US bonds before the inflation data was released. Results of a Morgan Stanley survey of US bond clients up to the week ending August 11 showed that the bank's clients had reduced their long positions by 5 percentage points to neutral, while short positions remained unchanged this week. Over the past week, there has been a surge in demand for the 9/25, 12/25, and 3/26 SOFR options, with calls at 96.25 and 96.125 for 9/25 and 12/25 seeing increased demand, as traders hope to reflect further rate cuts in the remaining Fed meetings this year. A recent flow was a significant buyer of the SOFR 9/25 96.125/96.25 call spread, targeting a 50 basis point rate cut at the September policy meeting, a similar structure also seen in the 12/25 expiry. The skew in US bond options remains close to neutral across the maturity structure, with slightly lower long-term bond options skewed towards puts. Recent trades in US bond options include a bet position on the 10-year US bond yield rising to around 4.33% before the close on Wednesday, with the premium for this trade slightly above $1 million.