A financial trader monitors his computer screens inside the Frankfurt Stock Exchange in Frankfurt, Germany. (Photographer: Hannelore Foerster/Bloomberg)

That Big Hedge-Fund Short Squeeze in Treasuries Is No Sure Thing

(Bloomberg) -- The “weakest hands” in the world’s biggest bond market -- speculators who can switch positions on a dime -- appear to have a much firmer grip than they’re given credit for.

Hedge funds have shown no signs of backing down from their unprecedented bets against U.S. Treasuries, even after yields plateaued and fell into a range the past three weeks. Sometimes referred to as momentum chasers or “fast money,” their unwavering commitment to short wagers indicates the pressure toward higher yields may not go away soon.

That’s a rebuff to bond bulls, who couldn’t help but get excited to see such a one-sided stance. After all, when speculators built up a then-record net-short position in 10-year Treasury futures in early 2017, they frantically covered those bets as the benchmark tumbled nearly 50 basis points in five weeks. In other words, their positioning can serve as a contrarian indicator: When those investors expect bonds to weaken, the market usually winds up rallying instead.

So far, though, that hasn’t happened. It shows how widening U.S. fiscal deficits, growing Treasury auctions and Federal Reserve rate increases -- which DoubleLine Capital’s Jeffrey Gundlach called a “pretty dangerous cocktail” this week -- are taking a toll.

“This is kind of mind-blowing that we can’t get a rally off of this type of speculative short in the Treasury bond market,” Gundlach, DoubleLine’s chief investment officer, said in a webcast. “You almost always get a rally,” he said, “but now we’re just going sideways. So for the bulls of the world, this is not really all that corroborative.”

One Spark

Those who predict lower yields, like strategists at BMO Capital Markets and Citigroup Inc., say it’ll only take one event to ignite a rally. And just as the range-bound market calls the bullish case into question, it also raises doubts for the bears. The 10-year yield, which was at 2.97 percent as of 7:30 a.m. Thursday in New York, still hasn’t managed to break above its intraday high from January 2014. The recent peak was two weeks ago.

Yet speculators haven’t flinched. Their net-short position in 10-year futures in the week through May 1 was just off the record-high set a week earlier. In long-bond futures, the group turned net short for the first time in a year. They’ve also amassed a record bet against five-year Treasuries.

“What makes this time different is that the Fed is far along away from zero and there’s more conviction now that they’re not going to blink,” said George Goncalves, head of Americas fixed-income strategy at Nomura. “You also feel better about holding a short when there’s a ton of paper coming in down the road.”

Nomura forecasts the 10-year yield will rise to 3.25 percent by year-end. By contrast, BMO is sticking to its prediction for a return to 2.4 percent. Citigroup sees scope for a near-term rally to about 2.7 percent.

To get that bullish move, 10-year yields would first have to retreat about 15 basis points from the recent high-water mark of 3.03 percent, which would probably be enough to spook some speculators into covering short positions, said Jason Williams, a U.S. rates strategist at Citigroup.

‘Weakest Hands’

BMO strategists Ian Lyngen and Aaron Kohli say they generally consider the speculator bets to be “the weakest hands.” They say these investors will exit shorts if 10- and 30-year yields keep failing to break through their 2018 ranges.

That might ultimately prove the deciding factor: How long the fast money is willing to hang on. Just because JPMorgan Chase & Co.’s Jamie Dimon and Franklin Templeton’s Michael Hasenstab talk of 4 percent yields doesn’t mean that level will be achieved any time soon. In fact, the median estimate of 60 analysts surveyed by Bloomberg is for the 10-year rate to end 2018 at 3.14 percent.

The other question is who’s left to bet against Treasuries, with net positions already so stretched?

Traders are dealing with “Fed hikes, supply, inflation gradually materializing,” said Blake Gwinn, a strategist at NatWest Markets. “Most of the market still probably leans bearish.”

One thing’s for sure: With bond traders staking out positions around 3 percent for weeks now, the next move out of this range may prove pivotal.

©2018 Bloomberg L.P.

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