By Brian ChappattaHedge funds and other large speculators are trying to catch one of the biggest falling knives in financial markets.Theyre wagering, essentially, that the persistent flattening of the US yield curve has run its course.
Its a bet against whats been one of the $14.9 trillion Treasury markets clearest no-brainer trades, which has benefited as short-term interest rates have climbed with Federal Reserve rate hikes, while longerterm yields have been held relatively in check by stubbornly low inflation.
Last week, the spread between twoand 10-year Treasuries fell to the lowest since 2007.The flattening trend has caught the attention of everyone from Main Street to Wall Street because when the spread between short- and long-dated Treasuries falls below zero (otherwise known as an inverted yield curve), it has predicted each of the past seven recessions.
Though some would argue that market dynamics are different this time around, many are watching the curve closely for at least one signal that the economic expansion is flagging.For months, hedge funds have been bearish on Treasuries, regardless of maturity, expecting that Fed tightening and a swelling federal budget deficit would keep interest rates marching higher.
And, to a large extent, theyve been proven correct.
When Treasuries rallied and US yields tumbled on May 29 amid escalating Italian political turmoil, they appear to have doubled down (rather than getting washed out), boosting their net short position in 10-year note futures to an unprecedented level.Whats striking lately, though, is that the same speculator group is growing more convinced that shorter maturities will rally.
Theyve increased their net long position in two-year Treasury note futures to the highest since November 8, 2016.
In five-year futures, they pared their net short position by the most in a decade.Now, the Commodities Futures Trading Commission data is for the week ended May 29 that is to say, it doesnt capture the Treasury sell-off and curve flattening that followed the steep one-day rally.
And speculators are considered to the most likely to quickly switch positions on any sign of opportunity or trouble.
In the ensuing few trading sessions, their short positions at the long end of the curve have paid off, but going long two-year Treasuries has been a losing proposition.These speculators wouldnt be the first ones to take a stab at a curvesteepening wager, only to fail.
Its been a common trade in the Treasury market in recent months.
After all, timing a big reversal correctly could single-handedly make a traders year.It doesnt hurt that Fed officials are starting to take notice.
Several policy makers stressed the importance of monitoring the slope of the curve because of the ties between an inverted curve and the risk of recession, according to minutes of their May meeting.
If theres a point at which the central bank would hold off on rate hikes to avoid further flattening, that would bolster the speculators stance.Still, there are few signs from the most important members of the Fed that the market has reached that point just yet.
Incoming New York Fed President John Williams reiterated the need for gradual rate increases, saying the central bank is about three hikes away from reaching a neutral level that neither adds nor takes away from economic growth.
And theres no reason to necessarily stop raising rates from there.Its curious timing for hedge funds and speculators to position for steepening, with Fed policy makers all but guaranteed to raise rates when they meet next week.
If the past few increases are any guide, theres no clear curve trade in the days after the decision.
Of course, the longterm play has ended in flattening.Its unlikely that speculators have finally cracked the yield curves code.
Its more likely that the sudden jump in volatility left them questioning the path of Fed hikes.
Some surely scrambled to cover their short positions during the fleeting rally at least on the short end.Either way, itll be interesting as a spectator if these hedge funds stick to their wagers.
Because theyre either going to get rich quick, or humbly bow out like many others before them.By Brian ChappattaHedge funds and other large speculators are trying to catch one of the biggest falling knives in financial markets.Theyre wagering, essentially, that the persistent flattening of the US yield curve has run its course.
Its a bet against whats been one of the $14.9 trillion Treasury markets clearest no-brainer trades, which has benefited as short-term interest rates have climbed with Federal Reserve rate hikes, while longerterm yields have been held relatively in check by stubbornly low inflation.
Last week, the spread between twoand 10-year Treasuries fell to the lowest since 2007.The flattening trend has caught the attention of everyone from Main Street to Wall Street because when the spread between short- and long-dated Treasuries falls below zero (otherwise known as an inverted yield curve), it has predicted each of the past seven recessions.
Though some would argue that market dynamics are different this time around, many are watching the curve closely for at least one signal that the economic expansion is flagging.For months, hedge funds have been bearish on Treasuries, regardless of maturity, expecting that Fed tightening and a swelling federal budget deficit would keep interest rates marching higher.
And, to a large extent, theyve been proven correct.
When Treasuries rallied and US yields tumbled on May 29 amid escalating Italian political turmoil, they appear to have doubled down (rather than getting washed out), boosting their net short position in 10-year note futures to an unprecedented level.Whats striking lately, though, is that the same speculator group is growing more convinced that shorter maturities will rally.
Theyve increased their net long position in two-year Treasury note futures to the highest since November 8, 2016.
In five-year futures, they pared their net short position by the most in a decade.Now, the Commodities Futures Trading Commission data is for the week ended May 29 that is to say, it doesnt capture the Treasury sell-off and curve flattening that followed the steep one-day rally.
And speculators are considered to the most likely to quickly switch positions on any sign of opportunity or trouble.
In the ensuing few trading sessions, their short positions at the long end of the curve have paid off, but going long two-year Treasuries has been a losing proposition.These speculators wouldnt be the first ones to take a stab at a curvesteepening wager, only to fail.
Its been a common trade in the Treasury market in recent months.
After all, timing a big reversal correctly could single-handedly make a traders year.It doesnt hurt that Fed officials are starting to take notice.
Several policy makers stressed the importance of monitoring the slope of the curve because of the ties between an inverted curve and the risk of recession, according to minutes of their May meeting.
If theres a point at which the central bank would hold off on rate hikes to avoid further flattening, that would bolster the speculators stance.Still, there are few signs from the most important members of the Fed that the market has reached that point just yet.
Incoming New York Fed President John Williams reiterated the need for gradual rate increases, saying the central bank is about three hikes away from reaching a neutral level that neither adds nor takes away from economic growth.
And theres no reason to necessarily stop raising rates from there.Its curious timing for hedge funds and speculators to position for steepening, with Fed policy makers all but guaranteed to raise rates when they meet next week.
If the past few increases are any guide, theres no clear curve trade in the days after the decision.
Of course, the longterm play has ended in flattening.Its unlikely that speculators have finally cracked the yield curves code.
Its more likely that the sudden jump in volatility left them questioning the path of Fed hikes.
Some surely scrambled to cover their short positions during the fleeting rally at least on the short end.Either way, itll be interesting as a spectator if these hedge funds stick to their wagers.
Because theyre either going to get rich quick, or humbly bow out like many others before them.