(Repeated to expand readership)
ORLANDO, Fla., Oct. 4 (Reuters) – 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 they have built their largest long position in 10-year US Treasuries in four years and increased their multi-billion dollar bet on a stronger greenback to the largest in 18 months.
These trades – betting 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 22nd 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 announced its monetary policy statement to 1.55% this week, and the two-year / 10-year yield curve has steepened by 15 basis points up to 125 bps.
But the warning bells are ringing. The S&P 500 posted 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 becoming gloomy.
This environment favors bonds, a flatter yield curve and the dollar. For at least this last note, the funds are aimed at a winner.
CFTC data shows they increased their net long stocks by nearly $ 2 billion to $ 15.3 billion for the 11th straight week. That is the highest value since March last year.
The dollar appreciated for the fourth straight week, hitting an 11-month high against a basket of currencies, supported by rising short-term real yields, demand for safe havens, and a surge in ultra-short exchange rates due to the US debt ceiling impasse.
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 constraints and a cautious consumer.
Their third quarter GDP tracker closed at 3.4% last week, suggesting further downside risks to their official 4.5% forecast.
However, the hottest topic for investors right now is of course inflation. Are the current elevated levels temporary, as the Fed is still insisting? Is there a more damaging, longer lasting overshoot in the cards? More importantly, what will the Fed do?
With all the talk of prevailing inflation, some key measures of inflation expectations offer a different perspective.
Break-even inflation rates across the curve have increased since the Fed’s September 22nd meeting, but they are still well below their beginning of the year. Inflation-protected government bonds, or TIPS for short, have also fallen in price since then.
Goldman Sachs economists have just raised their 2021 core PCE inflation forecast – the Fed’s preferred metric – from 3.9% to 4.25%. But their year-end projections for the next three years are 2.00%, 2.15% and 2.20% – hardly galloping inflation.
This is the kind of outlook that suggests that current price pressures will indeed prove to be temporary, in which hedge funds and speculators appear to be buying – for now, at least.
Reporting by Jamie McGeever Editing by Steve Orlofsky