Written by Jimmy McGyver
ORLANDO, FL (Reuters) – It will prove true one day, but not yet.
Hedge funds continue to bet that the US Federal Reserve will end its rate-raising cycle soon enough, and then start easing soon enough as growth and inflation declines.
But as US inflation, inflation forecasts, and Federal Reserve officials point out, that pivot is out of reach โ the Fed’s implied final interest rate rose last week to a new high of close to 5.00%, and the two-year Treasury yield hit an all-time high. In 15 years. Above 4.50%, the “2s/10s” yield curve has been the most inverted since 2000.
The CFTC report for the week ending October 11 shows that hedge funds reduced their net short positions in the three-month CFO futures contracts to 552,462 contracts from 618,830 in the previous week. This was the fourth consecutive week that funds reduced their collective bet on higher US interest rates.
A short position is basically a bet that the price of the asset will go down, and a long position is a bet that it will go up. In bonds and rates, yields fall when prices rise, and rise when prices fall.
Hedge funds take positions in US short-term interest rates and bond futures for hedging purposes, so CFTC data do not reflect purely directional bets. But they are very good evidence.
Funds now hold their smallest three-month net short SOFR position since July, and it has largely halved in the past six weeks.
(SOFR status of CFTC funds https://fingfx.thomsonreuters.com/gfx/mkt/klpykxwjkpg/CFTCSOFR.png)
side risks
Granted, with over a million contracts in late August and early September, that wasn’t just a record short position, it was far bigger than anything we’d seen before. The leveraged trading community may have turned too bearish.
So backtracking was always more likely. But the decline coincided with continued high interest rates, yields and the Federal Reserve’s short-term outlook. Last week, traders briefly priced in the one in ten probability that the Fed’s next move in two weeks will be a 100 basis point increase.
(implied SOFR rates – 2023 https://fingfx.thomsonreuters.com/gfx/mkt/dwvkrowqdpm/sofr.png)
โGiven that high core services inflation should continue in the near term, there is some upside risk that the Fed could be aggressive in tightening…either by the end of the year or in terms of rally for longer,โ TD Securities analysts wrote on Friday. .
Macro hedge fund strategies are significantly outperforming benchmark markets and hedge fund strategies this year because the funds have been largely on the right side of huge moves in the dollar, commodities and rates.
The HFR aggregate index for the hedge fund industry data provider rose 12.83% in the first nine months of the year. It’s on track for the biggest annual rise since its launch, beating a previous best of 6.3% from 2010.
inverse curve
Funds have done better with yield curve trades in the US to settle trades in recent weeks.
The latest CFTC figures show that speculators trimmed their net short positions in 10-year Treasuries to 340,163 contracts in the week ending October 11, from 366,872 in the previous week.
They also increased the two-year net short-term dollar futures contract to 353,686 contracts from 306,134.
There have only been 11 weeks of larger net selling trades since the contract was launched more than 30 years ago.
Citi’s interest rate strategy team believes that short rates may struggle to rise much higher from here because the “evil synergy” caused by higher borrowing costs has already significantly tightened financial conditions and increased market volatility.
โWith the 2s already at 4.5% and the final Fed funds rate in March 2023 at around 5%, it seems unlikely that the 2s can sell much more in the near term. There may not be more in the 2s/10s to flatten,โ they wrote on Friday.
(US yield curve 2s/10s https://fingfx.thomsonreuters.com/gfx/mkt/xmpjozmqrvr/2s10s.png)
(The opinions expressed here are those of the author, who is a Reuters columnist.)
Related columns:
Central Banks Still Buying US Bonds – But FX Campaigns May Be Disrupted (October 11)
Fed Neutral Rate Expectations Point to ‘Temporary’ Pivotal Gestures (Sep 28)
(Reporting by Jamie MacGyver; Editing by Ana Nicholas da Costa)
