Hedge funds supercharged bearish Treasury bets to historic levels just days before the US banking turmoil took a turn for the worse and spurred a stampede for the world’s safest assets.
Leveraged funds boosted overall shorts on US bond futures to a fresh record in the week of May 2, according to a gauge of aggregate net positions based on the latest data from the Commodity Futures Trading Commission. That’s a seventh straight week of ramped-up bearish bets — the longest streak since 2017.
The positioning preceded a hectic week for Treasuries that saw a rally spurred by jitters around US regional banks and forecasts the Federal Reserve could pause its most aggressive tightening cycle since the 1980s. However, sentiment flipped again Friday as better-than-expected US jobs data dampened expectations of a pivot and propelled yields higher.
“We acknowledge there are some near-term risks — fears about smaller banks and an unresolved debt ceiling — that could further deepen cut pricing,” Goldman Sachs Group Inc. strategists including Praveen Korapaty wrote in a note. However, Fed cut bets are “likely overdone when viewed against a robust macro backdrop.”
Hedge funds’ bearish positions on US government bonds are at odds with Wall Street giants from Morgan Stanley to JPMorgan Chase & Co. who reckon fixed-income securities are a safer investment as the world’s biggest economy lurches toward a recession. Bond market pricing suggests the Fed is likely to cut rates by 75 basis points through December, despite policymaker pushback.
Basis Trades
Still, the persistence of leveraged fund bearish bets suggests the possibility that at least some of the positions are a result of the revival of the so-called basis trades. That’s when investors buy cash Treasuries and short the underlying futures in an attempt to profit from any difference in pricing.
They could also be a sign that some traders believe yields have slumped too low at a time when the Fed has yet to definitively halt rate hikes.
For investors such as Amy Xie Patrick, developments in the banking sector mean betting on Treasuries is now more nuanced.
“When the rates rally got extended post Silicon Valley Bank, I reduced my longs — I never went short,” said Xie Patrick, who helps manage the Pendal Dynamic Income Trust that’s beaten 96% of peers in the past year. “This isn’t the environment to be going short the one asset class that provides you positive carry and defense against risky tail events such as a more serious banking sector crisis.”
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