Hedge Funds Pile In to Long Bets on Bonds Just as Dangers Build

(Bloomberg) -- The fast money in the $14 trillion Treasuries market may turn out to be too slow.

For the first time since July, hedge funds and other large speculators are bullish on Treasuries across the yield curve, U.S. Commodity Futures Trading Commission data show. The shift in 10-year futures was particularly striking, with the group adding an unprecedented 255,942 net-long contracts as of the latest figures, covering the week through April 25. Their bias is so skewed toward gains that the group is the most vulnerable to a bond-market selloff since 2008.

Their change of heart came at a risky time. While almost no one expects the Federal Reserve to raise interest rates Wednesday, traders are betting that officials will reiterate a plan to hike twice more this year and potentially deliver further signals on their intention to trim the central bank's balance sheet. What's more, the same day, the Treasury is set to release documents as part of its quarterly refunding announcement that could shine light on the prospect of ultra-long debt issuance, which has already sent 30-year securities tumbling.

“I'm not sure why people are getting long the long-end of the market, especially in the face of the Fed, who's talking about reducing the balance sheet,” said Charles Comiskey, head of Treasury trading in New York at Bank of Nova Scotia. “There's a lot of risk” to being bullish on shorter-dated debt as well, he said.

Investors like hedge funds are usually contrarian indicators, with the market more often than not moving against them in the following month, according to JPMorgan Chase & Co.'s Jay Barry. He expressed skepticism about speculators' short positioning in late January. Those positions were subsequently squeezed out after yields fell to 2017 lows last month.

To be fair, hedge funds aren't suddenly all-in on a bond rally, and their long positions aren't nearly as large as their bearish wager to start 2017.

The Treasury market is “relatively clean and balanced” after the latest shakeout, said Ian Lyngen, head of U.S. rates strategy at BMO Capital Markets.

Still, “the pain trade would now be toward higher yields in the 10-year sector,” Lyngen said. Speculators are vulnerable since they turned long when “the market was at its lowest yield of the year.”

The benchmark 10-year yield has rebounded from its 2017 low of 2.16 percent on April 18. It was at 2.33 percent as of 6:37 a.m. New York time, climbing after Treasury Secretary Steven Mnuchin said Monday that ultra-long bond issuance could “absolutely” make sense.

On Wednesday, traders will look for detail on ultra-long debt sales in Treasury's May refunding. In its questionnaire released before the meeting, the department asked the primary dealers what it should consider when structuring a bond with a maturity longer than three decades.

They'll also be scrutinizing the Fed's economic outlook, after U.S. growth last quarter came in weaker than expected. The Citigroup Inc. U.S. Economic Surprise Index, which measures whether data beat forecasts, fell to its lowest level since October this week.

Bullish Fodder

That degree of disappointment might support bullish bond positions. Yet most strategists expect central bankers will look past the recent data misses, given that the unemployment rate is near the lowest in a decade and market-based measures of inflation expectations are close to policy makers' 2 percent goal.

For the June meeting, using the current effective fed funds rate and the forward OIS rate, the odds of a hike are about 60 percent, compared with 34 percent about two weeks ago.

And while the Trump administration's fiscal plans stalled during his first 100 days, supporting Treasuries, the initiatives could make a comeback. Republicans are determining whether they have the votes to pass an amended version of their health-care bill through the House, after leaders scrapped a planned floor vote in March.

“Given the likelihood that the economy rebounds in the second quarter, plus new risks coming out of Washington, it is a little dangerous to take an aggressive stance in the bond market,” said Gary Pollack, head of fixed-income trading at Deutsche Bank AG's Private Wealth Management unit in New York.

--With assistance from Edward Bolingbroke

To contact the reporter on this story: Brian Chappatta in New York at bchappatta1@bloomberg.net.

To contact the editors responsible for this story: Boris Korby at bkorby1@bloomberg.net, Mark Tannenbaum, Dave Liedtka