Hedge Funds Boosted Record Treasury Shorts as Markets Convulsed

(Bloomberg) — Hedge funds ramped up their bearish Treasuries bets to a record last week just as yields surged toward multi-month highs, while more traditional investors were burnt having boosted wagers in the opposite direction with similar conviction.

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Leveraged fund increased net-short positions of longer-maturity Treasuries derivatives to the most since figures going back to 2010, according to an aggregate of Commodity Futures Trading Commission data for the week to Aug. 1. Asset managers took opposite bets, taking their own net-bullish positions to an all-time high.

The clash underscores increasingly divergent investor views after a shock US credit rating downgrade, a hawkish Bank of Japan policy tweak and a bigger-than-expected Treasury issuance plan combined to pummel the US bond market. Thirty-year yields soared to nine-month highs last week, before paring the move after a mixed US jobs report reignited uncertainty around the Federal Reserve’s next policy move.

A closely watched measure of US inflation due this week looks likely to induce further volatility.

Leveraged funds “thought that inflation would only come down grudgingly and in that sense, they were right,” said Stephen Miller, investment strategist at GSFM in Sydney. As some funds “sold their Treasury longs — forcing yields upwards — leveraged investors were well positioned to take advantage of that.”

Hedge fund heavyweight Bill Ackman is among those betting on declines for 30-year US bonds as factors including increasing US bond supply dent the outlook for the securities. Speculative investors weren’t confined to just shorting longer-dated paper, also boosting five-year short futures positions to an all-time high, the CFTC data showed.

Yields on 10-year Treasuries resumed their advance Monday, rising two basis points to 4.06%. Those on 30-year US bonds edged one basis point higher to 4.21%.

Basis Trade

Some of the hedge fund bearish wagers could also be linked to the so-called “basis trade.” The strategy, which imploded spectacularly in 2020, has become popular once more as speculators seek to profit from small differences in the price between cash Treasuries and corresponding futures.

“Short positions in these few years seem to be largely due to the futures basis trade,” said Naokazu Koshimizu, senior rates strategist at Nomura Securities Co. in Tokyo. The selling may continue “unless there is a huge disruption in the Treasury market which deteriorates the basis trade.”

Asset managers on the other hand may continue to buy Treasuries as worries around slowing US growth spur bets for eventual rate cuts, according to Kenta Inoue, senior fixed-income strategist at Mitsubishi UFJ Morgan Stanley Securities Co. in Tokyo.

“Once the Fed stops raising interest rates, the next step must be cutting,” Inoue said.