October 4, 2021
By Jamie McGeever
ORLANDO, Florida (Reuters) – If the hedge fund plays on the dollar and US Treasuries are a weather vane for investors’ risk appetite and the overall economic outlook, then keep your hat on.
Chicago futures markets data shows they built their largest long position in 10-year US government bonds in four years and raised their multibillion dollar bet on a stronger greenback to its largest in 18. months.
These deals, which focus on low long-term financing costs, a flatter yield curve and a stronger dollar, indicate concern about future growth prospects, a strong desire for security or a lack of concern about inflation. Or all three.
Data from the Commodity Futures Trading Commission shows that in the week through September 28, hedge funds and speculators increased their net holdings of 10-year Treasuries by nearly 120,000 contracts to 181,207 contracts, the highest since October 2017.
This is the first look at how hedge funds are repricing interest rate risk since the Federal Reserve policy meeting on September 22, which opened the door to a faster and more aggressive tightening process than previously anticipated. .
The 10-year Treasury funds run completely reversed their sell-off before the meeting and coincided with a deterioration in financial markets as investors grappled with the prospect of an interest rate hike next year.
Reflecting the Fed’s hawkish bias, speculative accounts more than doubled their net short position on two-year Treasury futures to 62,829 contracts.
At least so far, this bet is not paying off: the 10-year yield jumped to 1.55% this week from 1.30% on the day of the Fed policy statement and the two-year / 10 yield curve. years increased by 15 basis points to 125 bps.
But the alarm bells ring. The S&P 500 had its first 5% drawdown in nearly a year and September marked the largest monthly drop since March last year; the VIX index jumped above 20; Consumer sentiment in the US has hit a seven-month low and near-term growth prospects are dimming.
This is the kind of environment that favors bonds, a flatter yield curve, and the dollar. At least on this final note, the funds are on a winner.
CFTC data shows that they increased their net long dollar positions for the 11th consecutive week, by nearly $ 2 billion to $ 15.3 billion. This is the largest since March last year.
The dollar strengthened for the fourth straight week reaching an 11-month high against a basket of currencies, driven by rising short-term real yields, safe-haven demand and a spike in short-term exchange rates to because of the US debt ceiling impasse.
The dollar often does well in times of slowing growth and growing economic uncertainty. At first glance, this seems counterintuitive, but in the relative world of exchange rates the dollar provides security and liquidity.
The domestic and global growth momentum is slowing. Barclays economists note that softening business investment is consistent with slowing demand amid renewed Covid-19 infections, ongoing supply constraints, and a cautious consumer.
The third quarter GDP tracker closed last week at 3.4%, suggesting further downside risks to their official 4.5% forecast.
However, the hottest issue for investors right now is inflation. Are the current high levels transient, as the Fed still insists? Is there a more damaging and longer lasting overshoot in the cards? And, more pertinently, what will the Fed do?
Despite all the talk of inflation taking hold, some key measures of inflation expectations offer a different perspective.
Full-curve break-even inflation rates have increased since the Fed meeting on September 22, but are still well below what they were at the beginning of the year. Inflation-protected Treasuries, or TIPS, have also fallen in price since then.
Goldman Sachs economists just raised their 2021 forecast for base PCE inflation, the Fed’s preferred measure, to 4.25% from 3.9%. But their year-end projections for the next three years are 2.00%, 2.15% and 2.20% – hardly runaway inflation.
This is the kind of outlook that suggests the current price pressure will prove to be truly transient, which hedge funds and speculators – at least for now – seem to be buying.
(Reporting by Jamie McGeever; Editing by Steve Orlofsky)
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