By Jamie McGeever
ORLANDO, Fla. (Reuters) – Hedge funds entered February holding their biggest ever short position in two-year U.S. Treasuries futures.
That’s what the most up-to-date Commodity Futures Trading Commission (CFTC) data shows, and it fits hand in glove with the rise in the two-year yield to a 16-year high last week and the most inverted 2-year/10-year yield curve in 40 years.
The CFTC positioning data is for the week ending Feb. 7. It is lagging by three weeks due to a cyber attack a month ago on the derivatives platform of ION Group, which has delayed trading firms’ reporting.
Still, it is the latest snapshot of how speculative accounts are playing the dramatic repricing of Fed expectations and the short end of the U.S. bond market.
As of Feb. 7, funds’ net short position in two-year Treasury futures stood at a record 658,802 contracts, up by more than 80,000 contracts from the week before.
Graphic 3: CFTC 2-year Treasuries – record net short position, https://fingfx.thomsonreuters.com/gfx/mkt/lgpdkoqamvo/CFTC2Y.png
If funds have remained on the right side of the continued rise in yields since then, their short position is probably even greater now.
On the other hand, the more the record short position grows and the higher yields go – 5% for an essentially risk-free investment will be tempting to many – the closer the bond market is to a powerful rebound.
Graphic 1: US 2-year Treasury yield – highest since 2007, https://fingfx.thomsonreuters.com/gfx/mkt/akpeqojnkpr/US2Y.png
A short position is essentially a wager that an asset’s price will fall, and a long position is a bet it will rise. In bonds and interest rates, yields and implied rates fall when prices rise, and move up when prices fall.
Hedge funds take positions in short-dated U.S. rates and bonds futures for hedging purposes and relative value trades, so the CFTC data is not reflective of purely directional bets. But it is a pretty good guide.
FLIP-FLOP ON FED
The two-year yield last week reached 4.95%, the highest since July 2007. It rose 60 bps in February, the third steepest monthly climb since 2008.
This historic rise has crushed the 2s/10s yield curve to a 90 basis points inversion. An inverted curve has long been seen as a reliable indicator of recession, but many are questioning its usefulness in the topsy-turvy post-pandemic world.
Analysts at Deutsche Bank reckon current yields will attract plenty of buyers. They see the two-year yield falling to 3.55% in the third quarter and 3.15% by the end of this year.
Graphic 2: US 2s/10s yield curve – inverted by 90 bps, https://fingfx.thomsonreuters.com/gfx/mkt/byprlqbxgpe/2s10sCurve.jpg
The market’s repricing of the U.S. rate outlook this year has been staggering. At the start of February the implied peak for the current cycle of interest rate rises was under 5% and the year-end rate was around 4.40%.
But punchy inflation and economic activity data, and subsequent fighting talk from Fed officials have redrawn the map: the terminal rate last week topped 5.50% and the year-end rate rose above 5.30%.
Perhaps most remarkable of all, the expected inflation rate implied by the yield difference between ordinary and inflation-linked two-year Treasury bonds has smashed through 3%. Barely six weeks ago it was 2%.
Put all that together and the idea of the Fed lifting the fed funds rate to 6% this year is no longer the stuff of wild fantasy it was only a few months ago.
So much so, hedge funds are also re-building their short position in SOFR interest rate futures contracts after they seemed to have completely thrown in the towel on higher rates bets.
Funds were net short 209,302 three-month Secured Overnight Financing Rate contracts in the week ending Feb. 7, the biggest net short position this year.
Funds’ net short SOFR position reached 1 million contracts at the end of last August. That was steadily wiped out over the next five months as traders bet that the Fed would soon pivot towards a pause then start cutting rates this year.
The stampede to bet on higher rates shows that speculators have flipped again, only this time much more quickly.
(The opinions expressed here are those of the author, a columnist for Reuters.)
Related columns:
– Rates market overshoot – or no man’s land?
– Funds start 2023 short dollars, eyeing U.S. rate peak
(By Jamie McGeever; Editing by Bradley Perrett)
