Hedge funds eye U.S. bond increase after bruising Q1: McGeever

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ORLANDO — For the U.S. bond market, the primary quarter was marked by traditionally excessive volatility and the poorest efficiency in a long time. Hedge funds scored badly, and might be hoping for a greater displaying within the second quarter.

U.S. futures market positioning within the first week of the brand new quarter confirmed that funds usually bought it proper on the transfer up in short-dated charges and yields, however didn’t anticipate the spike larger within the 10-year yield.

It was a combined bag on the relative worth commerce between two- and 10-year Treasuries, the carefully watched “2s/10s” yield curve. The curve flattening that funds positioned for got here to move, however solely briefly.

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Commodity Futures Buying and selling Fee information confirmed that funds minimize their internet quick 10-year Treasuries place within the week to April 5 by 113,682 contracts to 362,875, and elevated their internet quick place in two-year bonds to 72,194 contracts from 59,202.

That was basically a guess on the 10-year yield falling, and the two-year yield rising.

The ten-year yield rose to 2.55% from 2.40% in that week and has continued to soar, reaching a three-year excessive on Monday of two.77%. The 2-year money yield jumped by round 30 foundation factors to 2.60% within the week to April 5.

A brief place is actually a guess that an asset’s value will fall, and a protracted place is a guess it can rise. In bonds, yields rise when costs fall, and transfer decrease when costs rise.

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Taken collectively, these CFTC place shifts have been a collective guess on a flatter “2s/10s” curve. The curve inverted by as a lot as 8 foundation factors on April 4 earlier than quickly steepening to +20 bps a number of days later.

Q1 CURVE TRADES CRUSHED

Hedge funds typically take long-term directional bets and thrive on the arbitrage alternatives created by rising volatility. Whereas funds appeared to get it at the very least partially proper because the second quarter began, with regard to their Treasuries bets, the primary quarter was extraordinarily difficult.

Business information supplier HFR mentioned on Friday its Relative Worth Fastened Earnings-Sovereign Index misplaced 2.66% within the first quarter, the worst efficiency for 2 years and a stark distinction to the 7.71% surge in its broader Macro Index.

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Evaluating the shifts in CFTC Treasuries futures positioning within the January-March interval with strikes in U.S. yields reveals that funds bought the directional bets on larger yields proper, however have been crushed on their curve trades.

Funds elevated their 10-year bond internet quick place by nearly 265,000 contracts and their two-year internet quick place by 147,000 contracts, successfully a guess that the 10-year yield would rise by greater than the two-year yield.

The ten-year yield rose round 83 bps within the quarter, however the two-year yield surged 160 bps, the most important quarterly rise in over 40 years. The curve flattened by 77 bps, probably the most since 2011.

The overwhelming consensus now could be that the Fed is about to undertake probably the most aggressive coverage tightening in a long time by way of steep rate of interest hikes and a fast discount of its steadiness sheet.

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So the place does the curve go from right here?

Analysts at Citi observe a reasonably substantial quantity of easing is already priced into U.S. cash markets from the anticipated peak in charges within the second half of subsequent 12 months, suggesting there could also be restricted room for the curve to flatten additional.

However analysts at Morgan Stanley argue that an inverted yield curve “is right here to remain,” with out essentially flagging recession forward.

If a transparent development emerges over the course of the quarter, funds might be hoping they’re on the precise aspect of it this time.

Associated columns:

– Chilly consolation in re-steepening U.S. yield curve (Reuters, April 8)

– Wage-price spiral alarm dangers prolonging actual revenue funk (Reuters, April 8)

– Elusive bond threat premium misses its curtain name (Reuters, March 30)

– ‘Japanification’ nonetheless lurks behind hawkish Fed frenzy (Reuters, March 29)

– Merciless to be sort – Fed appears tempted by 1994 playbook (Reuters, March 23)

– To impartial … and past! U.S. fee outlook rises after Fed liftoff (Reuters, March 16)

(The opinions expressed listed here are these of the creator, a columnist for Reuters.)

(By Jamie McGeever; Modifying by Andrea Ricci)