LONDON (Reuters) – Struggling for returns this year, hedge funds are throwing caution to the wind, building up record bets on higher U.S. Treasury yields across the curve and increasingly large bets on a stronger dollar.
A money changer counts U.S. dollar banknotes at a currency exchange office in Diyarbakir, Turkey May 23, 2018. REUTERS/Sertac Kayar
Either these wagers pay off, especially in fixed income, or for speculators, things may be about to go “pop”.
The latest data from U.S. futures exchanges show that hedge funds and speculators last week accumulated a record short position in five-year, 10-year, and 30-year Treasuries futures, and also expanded their short position in two-year notes.
Commodity Futures Trading Commission figures show they now hold a record net short position of 715,965 contracts in five-year Treasury futures, 509,498 contracts in 10-year futures, and 212,674 contracts in 30-year futures.
(For a graphic showing Spec 5-yr Treasuries position, click here: reut.rs/2mQqFB4)
(For a graphic showing Spec 10-yr Treasuries position, click here: reut.rs/2mTXZXS)
(For a graphic showing Spec 30-yr Treasuries position, click here: reut.rs/2K8npdI)
It’s been a tough year for hedge funds, particularly in the “macro” space of interest rates and currencies. The U.S. Federal Reserve, far and away the global leader in removing crisis-era stimulus, has raised rates twice this year and has indicated it will deliver another two increases before 2019.
But the muted rise in longer-dated bond yields shows investors are sceptical the U.S. economy can take many more rate hikes, and that the Fed may even have to start cutting rates in the not-too-distant future.
The U.S. economy has entered its 10th year of expansion, the second longest on record. Unsurprisingly, the likelihood of recession in the next year or two is increasing, as shown by the yield curve flattening to within 24 bps of outright inversion.
According to Eurekahedge, hedge fund returns in the first six months of the year were just 0.05 percent across all strategies. The CTA/managed futures index, which include CFTC-related rates and FX bets, was down 1.99 percent, and the macro fund index was down 0.29 percent.
The fixed income index was up 0.33 percent in the first six months of the year, but down 0.37 percent in the three months to June.
CFTC data show that hedge funds and speculators have grown their net short position in 10-year Treasury futures by 425,832 contracts so far in 2018, on course for a calendar year record, while the 30-year net short has doubled this year.
Long yields haven’t risen much, however, certainly not as much as these short positions would suggest hedge funds had hoped. The 10-year yield is up around 55 bps and the 30-year yield around 35 bps, struggling to break above 3 percent and 3.2 percent, respectively.
The 2s/10s curve, meanwhile, has flattened to levels last seen before the Great Financial Crisis, more than a decade ago.
In currencies, funds continued to increase their long dollar position, which is now the biggest since January last year and collectively now worth $21.8 billion against a range of major and emerging currencies.
Two notable developments within that broad shift stood out — funds opened up their biggest short position in the yen for four months, and the biggest short position in sterling since September last year.
Bearish momentum in the British pound is now the strongest in five years and the second-strongest since CFTC positioning data was first compiled 20 years ago. The speculative trading community, at least, does not seem to think Brexit negotiations are going well.
(For a graphic showing Spec sterling positioning momentum, click here: reut.rs/2mRKVlR)
Funds have fared better this year in FX than bonds, but not much better. By late April, they had built up their biggest short position for seven years. That was “in the money”, as the dollar index hit a three-year low in February.
But it didn’t weaken any further, so for more than two months that large short position was becoming a large money-loser for funds. The dollar started turning in April and has risen 6 percent since, prompting a stunning $50 billion positioning U-turn from speculators and funds.
Their net long dollar position of $21.8 billion now compares with a $28.2 billion net short on April 20.
Eurekahedge’s FX hedge fund index was up 0.91 percent in the first six months of the year, easily outperforming the macro and other rates-related strategies, but still way below what hedge fund investors will be paying out in management fees.
The opinions expressed here are those of the author, a columnist for Reuters.
Reporting by Jamie McGeever; Editing by Catherine Evans