Hedge funds and other leveraged speculators held hefty short positions on long-dated Treasurys, betting that inflationary pressures and the U.S.’s strong momentum would hammer the bond market and send yields higher, said market participants. Bearish bond bets reflect the opinion that bond prices will fall, driving yields higher. Bond prices move in the opposite direction of yields.
But those bearish bets appeared to unwind in spectacular fashion recently, in what investors including Jeff Gundlach of DoubleLine Capital dubbed a classic short squeeze on Tuesday. A short squeeze refers to forced buying that occurs when short wagers, or bets that an assets price will fall, are unwound, which can also magnify the assets price swing.
The 10-year Treasury note TMUBMUSD10Y, -1.72% fell 6.9 basis points, while the 30-year bond yield TMUBMUSD30Y, -1.49% showed a more marked decline of 10.2 basis points. Both maturities plunged below their 200-day moving averages, a charting level once pierced could presage further yield dips, according to market technicians.
“I probably had more calls on what was going on in the market than I’ve had in over a year,” said Tom di Galoma, managing director of Treasurys trading at Seaport Global Securities, referring to Tuesday’s market action.
Hedge funds and other speculators’ conviction over the viability of bearish trades were already on the wane. The Commodity Futures Trading Commission showed that net bearish wagers in 10-year Treasury futures TYZ8, +0.42% were down to 284,233 contracts for the week ending in Nov. 27 from an all-time high of 756,316 contracts on Sep. 25.
A pullback of inflation expectations after crude prices CLF9, -3.72% slumped, and a perceived dovish shift in the Federal Reserve’s tone over next year’s rate increase trajectory provided the tinder to set short positions ablaze. In addition, traders said the bond market had overextended itself when the 10-year yield hit a seven-year high at 3.261% in early November.
“Any move in the bond market where its tends to move too far, ends up mean reverting,” said Charles Ripley, senior investment strategist at Allianz Investment Management, referring to the statistical condition where long-run values return to their average.
John Canavan, market strategist at Stone & McCarthy Research Associates, pointed to the sharp decline in open interest as a sign of short-covering in long-dated Treasurys.
He reported open interest, the number of futures contracts trading at any one time, for 30-year bond futures USZ8, +0.83% fell around 16% over the past four trading sessions. When prices for bond futures rise as open interest declines, investors say it can be an indication that speculators and hedge funds closing out their short positions are driving the Treasury market’s rally.
Many of the traders shorting U.S. government debt were making use of borrowed funds, too, meaning their capacity to hold fast on to their bond-market bets were much weaker than those who didn’t employ leverage, or additional debt against their bets used to magnify returns. Such investors had placed more than 820,000 contracts on net bearish wagers on 10-year Treasury futures in the week ending at Nov. 27, CFTC data show.
Leveraged bets tend to be subject to margin calls, when a broker demands that a client that is losing money pony up additional funds to meet minimum maintenance requirements. Such calls can also amplify upside and downside moves.
“We’re seeing some of this short-covering because some of these investors were holding these positions on a levered basis, so it doesn’t take much to get squeezed out,” said Jim Sarni, a portfolio manager at Payden & Rygel.
On Wednesday, the bond and stock markets were closed in honor of the national day of mourning for George H.W. Bush, the 41st U.S. president, who died at 94.
The iShares 20+ Year Treasury Bond ETF (TLT) was trading at $118.81 per share on Thursday afternoon, up $0.99 (+0.84%). Year-to-date, TLT has declined -5.55%, versus a -0.33% rise in the benchmark S&P 500 index during the same period.
This article is brought to you courtesy of MarketWatch.