June 4, 2018 / 11:44 AM / 21 days ago

Commentary: Hedge funds in the money with dollar bets, struggling with Treasuries

LONDON (Reuters) - Hedge funds are having mixed fortunes with their currency and U.S. bond bets: Their growing faith in the dollar is being rewarded but they’ve chosen the wrong time to open up a record short position in 10-year Treasuries.

A man counts U.S dollar bills at a money exchange office in central Cairo, Egypt, March 7, 2017. REUTERS/Mohamed Abd El Ghany

The 10-year yield’s pop above 3 percent and rise to a seven-year peak of 3.13 percent in mid-May looks to have convinced many speculators to double down on their short bond positions on the expectation that the only way for yields was up.

The latest Commodity Futures Trading Commission figures show that hedge funds and specs increased their net short position in 10-year Treasury futures by 112,440 contracts in the week to May 29 to a record net short 471,067.

(For a graphic showing CFTC spec position in 10y Treasuries, click here: reut.rs/2LjA4ve)

That date is important. It’s when the political crisis in Italy reached fever pitch, sparking turmoil in Italian bonds and a global scramble for shelter. Yields on safe-haven government bonds like Treasuries, Bunds and gilts tumbled.

The 17 basis point decline in the 10-year U.S. yield that day was the biggest fall in almost seven years. The yield fell as low as 2.75 percent, completely wrong-footing all those hedge funds who had increased their short positions.

The CFTC data show that hedge funds also increased their net long position in two-year Treasury futures to 62,892 contracts, the largest net long position since November 2016.

(For a graphic showing CFTC spec position in 2y Treasuries, click here: reut.rs/2LkWFaY)

The combined moves in 10- and two-year positioning was effectively a bet on a steepening yield curve. But the curve has flattened in recent weeks, going as low as 40 basis points on May 31, the flattest since 2007.

U.S. economic data, most notably May’s employment report, suggest the Fed will stick with its stated plan to raise interest rates in a gradual manner. An increase next week is widely expected, followed by another before the end of the year.

Still, that’s only two more rate hikes this year fully priced in. Investors have consistently been more cautious than the Fed on the path of U.S. interest rates in recent years, and have consistently been proved right. Will it be different this time?

If speculators are struggling with their Treasuries trades, they’re having better luck with the dollar.

The latest CFTC data show that they cut their net short dollar position for the sixth week in a row to the lowest level in five months. In the week of May 22-29, the dollar rose 1.5 percent and the euro fell to its lowest in almost a year, managing to hold above $1.15 by the skin of its teeth.

Hedge funds’ net short dollar position is now worth $5.19 billion, compared with a multi-year extreme of $28.18 billion on April 20. The dramatic shrinking of that short position has coincided with the dollar rallying some 4 percent.

(For a graphic showing CFTC spec position in US dollar, click here: reut.rs/2JreqYI

Overall, it continues to be a tough environment for hedge funds trading FX and interest rates. BarclayHedge’s macro fund index fell 1.67 percent in May, and is down 2.99 percent year to date.

These results are based on the preliminary data from just nine funds. But if they are representative, it will be the worst May performance since 2010, while macro funds are headed for their worst year since 2011, and second worst in two decades.

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

Reporting by Jamie McGeever; Editing by Hugh Lawson

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