When hedge funds are playing the dollar and US Treasuries are a weather vane for investor risk appetite and the economic outlook in general, hold on to your hats.
Chicago futures market data shows that they have built their largest long position in 10-year US Treasuries in four years and increased their bet on a stronger dollar to their largest in 18 months.
These trades – which bet on low long-term borrowing costs, a flatter yield curve, and a firmer dollar – indicate concerns about future growth prospects, a strong desire for security, or a lack of inflation concerns. Or all three.
Data from the Commodity Futures Trading Commission shows that in the week ending September 28, hedge funds and speculators increased their net long holdings of 10-year government bonds by nearly 120,000 contracts to 181,207 contracts, the highest since October 2017.
This is the first glimpse into hedge funds reassessment of interest rate risk since the Federal Reserve’s September 22 policy meeting, which opened the door to an earlier and more aggressive tightening process than previously anticipated.
Funds run on 10-year government bonds completely reversed their pre-session sell-off and coincided with deterioration in financial markets as investors grappled with the prospect of rising interest rates over the next year.
The speculative accounts reflected the Fed’s restrictive propensity to more than double its net short position in two-year Treasuries futures to 62,829 contracts.
So far, at least, that bet isn’t paying off: the 10-year yield jumped from 1.30% on the day the Fed declared it to 1.55% last week, and the two-year / 10-year yield curve has steepened by 15 basis points by 125 bps.
But the warning bells are ringing. The S&P 500 saw its first 5% decline in nearly a year, and September marked its largest monthly decline since March last year; the VIX index jumped over 20; US consumer sentiment hit a seven-month low and near-term growth prospects are clouding.
This environment favors bonds, a flatter yield curve and the dollar. For at least this last note, the funds are aimed at a winner.
The dollar often does well in times of slow growth and heightened economic uncertainty. At first glance this may seem counter-intuitive, but in the relative world of exchange rates, the dollar offers security and liquidity.
Domestic and global growth momentum is slowing. Barclays economists note that the slowdown in business investment is compatible with the slowdown in demand amid renewed COVID-19 infections, ongoing supply restrictions, and a cautious consumer.
Jamie McGeever is a columnist for Reuters.