Hedge funds’ extended short positions on Treasuries wrongly timed

CFTC data shows bets persisted even though the cash bonds had rallied the week before.

Hedge funds extended short positions on Treasuries to a record just before smaller-than-expected US bond sales and weaker jobs data spurred a rally.

Leveraged funds ramped up net short Treasury futures positions to the most in data going back to 2006, according to an aggregate of the latest Commodity Futures Trading Commission figures as of Oct. 31. The bets persisted even though the cash bonds had rallied the week before.

“It feels like short US Treasuries positioning was at an extreme last week, which was an accident waiting to happen,” said Gareth Berry, strategist at Macquarie Group Ltd. in Singapore. “Price action in Treasuries for the past few months was a classic case of a persuasive story feeding the price action, until it went too far, leading to an overshoot which is now correcting.”

Yields on 10-year Treasuries have fallen 43 basis points since their 5.02% peak on Oct. 23, as traders for the $26 trillion bond market swung back to pricing the end of rate hikes. The combination of more benign US refunding needs, weaker-than-expected jobs data and signs of the Federal Reserve turning less hawkish may have spurred wide-spread covering of short positions.

Investors may also have taken short positions as part of the basis trade, a strategy that seeks to benefit from small pricing mismatch between futures and the underlying bonds for the contract. The trade often involves heavy borrowing, which can worsen market volatility when funds are forced to close positions in a hurry.

According to the latest CFTC data, asset managers extended their bullish positions in Treasury futures.

Traders are pricing in more than 100 basis points of cuts by the end of next year from an expected peak rate of 5.37%, swaps data show. They have brought forward their predictions for the first cut to June from July following the policy decision and payrolls data.

US officials signaling discomfort with higher yields “puts the brake on momentum-driven selling,” Citigroup Inc. strategists including Jabaz Mathai wrote in a note. “The combination of weaker data, dovish signals from Powell and a better-than-expected refunding outlook means that Treasuries are likely to continue rallying” into the new week.