(The opinions expressed here are those of the author, a columnist for Reuters)
Hedge funds continue to bet on a flatter U.S. yield curve, but they are raising the stakes less and less, suggesting their conviction in the trade is ebbing as the end of the year approaches.
That shouldn’t come as a surprise - the curve was unlikely to continue flattening at such a rapid pace and positions were always vulnerable to profit-taking going into the holidays.
The latest data from the Chicago Futures Trading Commission show that speculators may have more confidence, however, in another profitable macro trade of recent weeks - they built up their biggest short dollar position in over a month.
The U.S. yield curve - the gap between two- and 10-year Treasury yields - fell to its flattest in a decade early last week, to 56 basis points. That’s just 56 basis points away from inversion, the classic red flag that recession is looming.
But that move stalled as the week progressed, so much so that the overall flattening over the week was less than a single basis point, the shallowest flattening in five weeks. This was reflected in the latest CFTC snapshot of hedge fund positioning.
Data to the week ending Nov. 28 show that speculators upped their net short two-year Treasury bond positions by 19,193 contracts to 246,433 contracts and increased their net long 10-year positions by 12,856 contracts to 123,936 contracts - bets that two-year yields will rise and 10-year yields will fall.
That was the smallest increase in two-year bearish bets in three weeks. And while bullish bets on the 10-year bond rose for a fourth straight week - a run not seen since March - it was the smallest rise of the four.
Hedge funds have found it hard to make money this year trading bonds and currencies, in part due to the chronic lack of market volatility. Barclays Global Macro Index is only up 3.99 percent year to date. A passive fund investment in world stocks at the start of the year would be up around 20 percent by now.
Traders are betting on higher short-dated yields in anticipation of further rate rises from the Federal Reserve, but predicting that longer-dated yields will be capped by low inflation and soft growth.
After weeks of rapid flattening, the yield curve may be about to level off or even steepen following the U.S. Senate’s approval on Saturday of what would be the largest change to U.S. tax laws since the 1980s.
The anticipated short-term fiscal boost to the U.S. economy could also throw a spanner in the works for hedge funds betting that the dollar will continue to fall.
The latest CFTC data show that the value of speculators’ net short dollar positions against a range of G10 major currencies and emerging market currencies rose by nearly $1 billion to $6.2 billion in the week to Nov. 28. That’s hedge funds’ biggest bet against the greenback in over a month.
But the U.S. tax cut package could scupper those bets, if the market's initial reaction is any guide. The dollar is up 0.4 percent on Monday, on course for one of its biggest daily rises in weeks.
Reporting by Jamie McGeever, editing by Larry King