© Reuters. FILE PHOTO: The Federal Reserve Board building on Constitution Avenue is pictured in Washington, U.S., March 19, 2019. REUTERS/Leah Millis/File Photo
By Jamie McGeever
ORLANDO, Fla. (Reuters) – They will one day be proven true, just not yet.
Hedge funds continue to bet that the US Federal Reserve will soon end its aggressive rate-raising cycle, then, after a brief pause, begin easing policy as growth and inflation goes down.
But as US inflation, inflation expectations and Fed officials point out, this pivot is far away – the Fed’s implied final rate last week rose to a new high of just 5.00%, 2-year Treasury yields hit a 15-year high above 4.50% and the ‘2s/10s’ yield curve inverted the most since 2000.
Commodity Futures Trading Commission report for the week to October 11 shows hedge funds cut their net short positions in three-month secured overnight funding rate futures down to 552,462 contracts from 618,830 last week. This is the fourth week in a row that funds have reduced their collective bets on a hike in US interest rates.
A short position is essentially a bet that the price of an asset will go down, and a long position is a bet it will go up. In bonds and interest rates, yields fall when prices rise, and rise when prices fall.
Hedge funds take positions at short-term US rates and bond futures for hedging purposes, so the CFTC data does not reflect pure directional bets. But they are a pretty good guide.
The funds are currently holding the smallest net 3-month short SOFR position since July and it has fallen quite a bit over the past six weeks.
(CFTC fund SOFR position https://fingfx.thomsonreuters.com/gfx/mkt/klpykxwjkpg/CFTCSOFR.png)
True, over 1 million contracts in late August and early September is not only a record short position, but it is significantly larger than anything seen before. The leveraged trading community has probably gone too low.
So a retreat is always possible. But this decline has coincided with interest rates, short-term yields and Fed expectations continuing to move higher. Traders last week briefly priced in a one in ten probability that the Fed’s next move in a few weeks would be a 100 basis point increase.
(SOFR implied rate – 2023 https://fingfx.thomsonreuters.com/gfx/mkt/dwvkrowqdpm/sofr.png)
“Given that high core services inflation will continue to linger in the near-term, there is some upside risk that the Fed will have to be more aggressive in tightening … at the end of the year or during longer bullish conditions. “, TD Securities analysts wrote on Friday.
Macro hedge fund strategies are significantly outperforming benchmark markets and hedge fund strategies this year because funds have largely stayed ahead of major dollar swings, every commodity and exchange rate.
Hedge fund industry data provider HFR’s Macro Index rose 12.83% in the first nine months of the year. This is, of course, the biggest year-over-year gain since launch, beating the previous best of 6.3% from 2010.
Funds have performed better with deals that have flattened their yield curve in recent weeks.
The latest CFTC figures show that speculators cut their net short position in 10-year Treasuries to 340,163 contracts in the week ending Oct. 11 from 366,872 the previous week.
They also increased their positions in the net US dollar two-year Treasury note contract to 353,686 contracts from 306,134.
There have only been 11 weeks of larger net buying since the contract launched more than 30 years ago.
Citi’s rate strategy team thinks short-term rates may find it difficult to move much higher from here on as “evil synergy” from rising borrowing costs has significantly tightened financial conditions and increased market volatility.
“With the 2s already at 4.5% and the Fed ending rate in March 2023 almost at 5%, it looks like the 2s could sell off even more in the near term. Probably not anymore. much more in 2s/10s,” they wrote on Friday.
(US 2s/10s yield curve https://fingfx.thomsonreuters.com/gfx/mkt/xmpjozmqrvr/2s10s.png)
(The opinions expressed here are those of the author, a Reuters columnist.)
Central banks are still buyers of US bonds – but FX campaigns could depreciate (October 11)
Fed neutral rate forecast accepts ‘temporary’, eventually swings (September 28)
(By Jamie McGeever; Editing by Ana Nicolaci da Costa)