Quiver Quantitative - Hedge funds aggressively increased their short positions on U.S. Treasury futures to a record high just as market conditions began to shift, leading to a significant rally in Treasury bonds. These extensive short positions were at their highest since 2006, according to the Commodity Futures Trading Commission data up to October 31st. This buildup of bearish bets was in stark contrast to the preceding week's bond rally, suggesting that many investors were caught off guard by the subsequent market movements. Strategists like Gareth Berry from Macquarie Group in Singapore noted that this excessive positioning was ripe for a reversal, which materialized as yields on 10-year Treasuries fell sharply from their October peak.
The bond market, worth $26 trillion, has seen a recalibration of expectations around Federal Reserve rate hikes, leading to a sharp drop in yields. Contributing factors included the announcement of less aggressive U.S. bond sales than anticipated, employment data falling short of expectations, and a perceived shift in the Fed's tone towards less hawkishness. These developments likely triggered a widespread unwinding of short positions. Furthermore, the use of the basis trade strategy by investors—where they exploit slight pricing differences between futures and the underlying bonds—can amplify market volatility, especially when positions are abruptly closed due to changing market conditions.
While hedge funds were heavily short, asset managers reportedly increased their long positions in Treasury futures, betting in the opposite direction. The market is now anticipating over a full percentage point of rate cuts by the end of next year, with expectations for the onset of cuts moving earlier than previously thought. This shift was reinforced by signals from U.S. officials suggesting unease with the higher yield environment, which may have put a damper on the momentum of selloffs and contributed to a more bullish outlook on Treasuries.
Post-Fed decision and employment data, the bond market saw an increase in open interest in two- and five-year note futures, indicating the establishment of new long positions. This aligns with the growing anticipation of rate cuts by the Fed in the following year. There were also minor declines in 10-year note positions, suggesting some short-covering took place, providing additional impetus to the rally in Treasuries at the end of the week.
This article was originally published on Quiver Quantitative