Hedge funds raised their bets last week on a flatter US yield curve and a stronger dollar. Their bond bet shows signs of coming good as the yield curve moves towards inversion, but their FX wager? Not so much. The gap between two- and 10-year US bond yields is just 25 basis points, the narrowest in over a decade. Every time it has turned negative since the early 1970s, recession has followed.
Whether "this time it's different" is the subject of intense debate. Hedge funds and speculators had built up a record net short position in 10-year Treasuries futures earlier this month, but reduced that fairly substantially last week. The latest Commodity Futures Trading Commission figures show they cut their record net short position of 500,000 contracts by 61,000 contracts, and trimmed their small net short position in two-year futures to zero.
Combined, that's effectively a bet on a flatter curve. Markets are beginning to price in the two further interest rate hikes this year that Fed looks committed to. With the US central bank on a steady but very gradual tightening path, there may be little scope for speculators to significantly alter their neutral positioning in two-year futures.
It's a different situation with 10-year bonds. Even after last week's reduction, hedge funds and speculators are still sitting on a hefty short position that, crucially, is struggling to make money. The 10-year yield has failed to break back above 3 percent for almost two months, and the curve is flattening relentlessly. That strongly suggests there is scope for speculators to throw in the towel and liquidate their large short position in the 10-year space.
Similarly, speculators are struggling with their bets on the dollar. They increased their net long dollar position in the latest week to nearly $18 billion, the biggest since March last year. They cut their net long euro position to the smallest in over a year and increased their net short sterling position to the largest in over a year.
But while the dollar is on the strong side, it hasn't really gone anywhere for a month. The longer the dollar treads water, the twitchier speculators will become. According to Barclayhedge, global macro hedge funds' returns were -0.24 pct in June, and are -1.06 pct year to date. Hedge fund tracker Eurekahedge data shows macro funds' returns were negative in May and June, albeit slightly, bringing year-to-date returns into the red too. CTA/managed futures funds' returns were -0.48 pct in June, and -2.35 pct so far this year.
The specific figures may vary, but the trend is clear: hedge funds have struggled in fixed income and currency trading this year. If there's momentum in either space, it's in bonds, where the curve looks as if it will invert sooner rather than later. It will be no surprise if they continue to scale back their short 10-year Treasury position in the weeks ahead.
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