Column-Leveraged funds’ record short Treasuries bets surge again: McGeever

By Jamie McGeever

ORLANDO, Florida (Reuters) – Leveraged funds trading U.S. Treasuries futures have increased their record net short position across the curve, which will do little to soothe growing concerns among regulators about the potential financial stability risks these bets pose.

Hedge funds have rapidly built up short positions in U.S. Treasuries futures this year as part of the so-called ‘basis trade’, a leveraged arbitrage play profiting from price differences between cash bonds and futures.

The Bank for International Settlements has warned that the huge build-up in speculators’ Treasuries positions “is a financial vulnerability”, and a recent Fed paper said it warrants “diligent monitoring”.

The price difference between cash bonds and futures is tiny, but funds make their money from high levels of leverage in the repo market and sheer volume of trade.

Commodity Futures Trading Commission (CFTC) data for the week ending October 17 show that leveraged accounts – those funds and speculators more likely to be active in the basis trade – grew across the two-, five- and 10-year space by 250,000 contracts to a total 4.71 million contracts.

That is significantly larger than the peak combined net short position from 2019 of just over 4 million contracts.

The move was particularly strong at the shorter end of the curve. Leveraged accounts increased net short position in two-year futures by 133,000 contracts to 1.554 million contracts and by 92,000 contracts in the five-year space to 1.753 million.

That’s a whisker from the two-year record net short of 1.558 million contracts in 2019, and a fresh record five-year net short.

A short position is essentially a wager an asset’s price will fall, and a long position is a bet it will rise. In bonds falling prices indicate higher yields, and vice versa.

But funds play Treasuries futures for other reasons, like relative value trades, and this year, the basis trade.

These trades appear to be a key factor behind the U.S. bond market’s steep decline in recent months, but by no means the only one.

Worries over the U.S. government’s fiscal health, increased debt issuance from Treasury, the Fed’s ongoing ‘quantitative tightening’ program, stronger-than-expected economic growth and a reassessment of the interest rate outlook have all contributed to the extraordinary bond selloff recently.

Yields across the curve last week hit their highest levels since 2006-07, and on Thursday the entire Treasury curve from one-month to 30-year yield maturities was within half a basis point of being above 5%.

(The opinions expressed here are those of the author, a columnist for Reuters.)

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