ORLANDO, Fla. (Reuters) – If hedge funds are playing on the dollar and U.S. Treasuries are a weathervane for investor risk appetite and the economic outlook in general, then brace yourself.
Data from Chicago futures markets shows they built their largest long position in 10-year U.S. government bonds in four years and increased their multibillion-dollar bet on a stronger greenback to its highest. big in 18 months.
These exchanges – betting on low long-term borrowing costs, a flatter yield curve and a firmer dollar – indicate concern about future growth prospects, a strong desire for security, or a lack of concern about future growth. inflation. Or all three.
Data from the Commodity Futures Trading Commission shows that in the week to September 28, hedge funds and speculators increased their net holdings of 10-year Treasuries from nearly 120,000 contracts to 181,207 contracts, the highest number since October 2017.
This is the first look at how hedge funds are reassessing interest rate risk since the Federal Reserve’s September 22 policy meeting, which opened the door to an earlier and more aggressive tightening process than planned.
The rush of funds to 10-year Treasuries completely reversed their liquidation ahead of the meeting and coincided with a deterioration in financial markets as investors grappled with the prospect of a year-round interest rate hike. next.
Reflecting the Fed’s hawkish slant, speculative accounts more than doubled their net short two-year Treasury futures position to 62,829 contracts.
For now at least, this bet is not paying off: the 10-year rate jumped this week to 1.55% against 1.30% on the day of the Fed’s policy statement, and the yield curve at 2 years / 10 years has steepened by 15 basis points. at 125 bps.
But the warning bells are ringing. The S&P 500 recorded its first 5% decline in almost a year, and September marked the largest monthly decline since March of last year; the VIX index jumped above 20; US consumer confidence has hit a seven-month low and the near-term growth outlook is darkening.
KING DOLLAR
It’s the kind of environment that favors bonds, a flatter yield curve, and the dollar. On that final note, at least, the funds are on a winner.
CFTC data shows they increased their net long dollar holdings for the 11th consecutive week, from nearly $ 2 billion to $ 15.3 billion. This is the largest since March of last year.
The dollar strengthened for a fourth week in a row to an 11-month high against a basket of currencies, boosted by rising short-term real yields, demand for safe-haven securities and soaring very short bill rates term because of the US debt ceiling. dead end.
The dollar often performs well in times of slower growth and increasing economic uncertainty. At first glance, this seems counterintuitive, but in the relative world of exchange rates, the dollar offers security and liquidity.
The domestic growth momentum in the United States and around the world is slowing. Barclays economists note that the slowdown in business investment is consistent with slowing demand amid new Covid-19 infections, persistent supply constraints and a cautious consumer.
Their third-quarter GDP tracker closed last week at 3.4%, suggesting further downside risks to their official forecast of 4.5%.
Right now, of course, the hottest issue for investors is inflation. Are the current high levels transient, as the Fed still claims? Is there a more damaging and lasting overshoot in the cards? And more relevantly, what is the Fed going to do?
Despite all the talk about settling inflation, some key measures of inflation expectations offer a different perspective.
Full-curve break-even inflation rates have risen since the Fed’s September 22 meeting, but they are still well below where they were earlier in the year. Inflation-Protected Treasury Bills, or TIPS, have also declined since then.
Goldman Sachs economists just raised their 2021 forecast for core PCE inflation – the Fed’s preferred measure – to 4.25% from 3.9%. But their year-end projections for the next three years are 2.00%, 2.15% and 2.20% – barely skyrocketing inflation.
This is the kind of outlook that suggests that the current price pressure will indeed prove transient, which hedge funds and speculators – at least for now – appear to be embracing.
The views expressed here are those of the author, columnist for Reuters.
Reporting by Jamie McGeever; Editing by Steve Orlofsky