LONDON (Reuters) – Not everyone buys into the view that the marathon U.S. economic expansion has enough momentum left to warrant interest rates and yields going much higher, but one group of investors is going all in: hedge funds.
Traders work on the floor of the New York Stock Exchange (NYSE) in New York, U.S., July 18, 2018. REUTERS/Brendan McDermid
The latest data from U.S. futures exchanges show that hedge funds and speculators increased their bets on higher yields across the whole Treasury curve last week, accumulating record short positions in five- and 30-year futures.
They also increased their bullish bets on the dollar to the largest since March last year, strengthening the conviction that the gap between the Fed and the rest of the world, when it comes to raising interest rates, is becoming a chasm.
Fed officials see no sign of the economy slowing, despite rising global trade tensions just as the cycle enters its 10th year, and so they expect to continue raising rates at a steady, gradual pace this year and next.
The latest Commodity Futures Trading Commission figures show hedge funds and other speculative trading accounts increased their net short positions in two-, five-, 10- and 30-year Treasury futures in the week to July 17.
They increased their five-year Treasury futures position by nearly 98,000 contracts to a new record net short 698,955 contracts, and extended 30-year futures by 19,115 contracts to a new record net short 209,909.
(For a graphic showing 5-year U.S. Treasuries – CFTC, click here: reut.rs/2LfOQYC)
(For a graphic showing 30-year U.S. Treasuries – CFTC, click here: reut.rs/2LJ8k3J)
They also expanded the net short 10-year futures position to 469,138 contracts, the third largest ever and within sight of the record 500,076 contracts from earlier this month.
In currencies, hedge funds and specs upped their long dollar bets, which are collectively now worth almost $20 billion against a range of major and emerging currencies. There’s been a near-$50 billion swing in dollar positioning since April.
(For a graphic showing Hedge funds’ dollar bets – CFTC, click here: reut.rs/2JMfhPK)
Yields rose across the curve last week, lifting the dollar to a one-year high. But can yields continue rising, and if so, how much higher can they go? The Fed is aiming to edge its fed funds rate to a “neutral” level where the economy is growing in line with its long-run potential and inflation is stable.
The problem with that is, no one knows exactly what it is and policymakers’ vary widely in their estimates of it. The flattening of the yield curve suggests investors reckon the Fed is approaching its stopping point.
The two-year yield has tracked the Fed funds rate pretty consistently and is the highest in a decade, while the five-, 10- and 30-year yields are, to varying degrees, running out of oxygen around 3 percent.
Especially at the longer end, there is persistently strong demand for relatively safe and highly liquid bonds from longer-term investors like pension funds and insurance companies. Yields of 3 pct or higher are particularly attractive right now.
Relatively high U.S. rates, yields and dollar are putting the squeeze on emerging markets, president Trump is cranking up the belligerent rhetoric on trade, and the U.S. yield curve last week moved to within 24 basis points of inverting.
Taken together, it’s legitimate to ask how much higher U.S. yields can go, especially with Trump openly criticizing the Fed’s rate-hiking policy. If the answer is not much, hedge funds have a decision to make: ride it out, hoping for their short bond bets to pay off, or cut and run?
According to Barclayhedge, global macro hedge funds’ returns were -0.19 percent in June, and are -1.02 percent year to date. There’s a long way to go, of course, but this would be the first year of losses for macro funds since 2011, and only the third since 1997, Barclayhedge data show.
The opinions expressed here are those of the author, a columnist for Reuters.
Reporting by Jamie McGeever