Bond traders are bracing for a potentially hawkish turn from the Federal Reserve as they ramp up their bearish positions in the market. Following a challenging period for US Treasuries in April, traders are adjusting their strategies in anticipation of a shift towards a more aggressive stance by the central bank.
The recent poor performance of US Treasuries, driven by indications of economic strength and persistent inflation, has led investors to reconsider their expectations for Fed interest-rate cuts. Instead of betting on rate reductions, traders are increasingly turning to short positions. Initially positioning for multiple cuts in 2024, market participants are now only pricing in one quarter-point reduction, with doubts emerging about whether any cuts will materialize at all.
Federal Reserve officials, including Chair Jerome Powell, have hinted at the possibility of maintaining higher rates for an extended period if economic data continues to show strength. With expectations running high for a hawkish tone from Powell in the upcoming Fed meeting, traders are adopting a defensive stance and preparing for further market losses, despite US yields reaching their highest levels since November.
Kathryn Kaminski, chief research strategist and portfolio manager at AlphaSimplex Group, noted the resurgence of the short bond trade, highlighting the effectiveness of short bond exposure in the current market environment. Hedge funds and commodity trading advisors (CTAs) have been actively building short positions, with CTAs nearing maximum short duration levels according to Bank of America analysts. JPMorgan Chase & Co.’s client survey also revealed a significant increase in short wagers, reaching the highest levels in three weeks.
Market data from futures trading indicates a rise in open interest for shorter-term maturities, particularly as US 2-year yields surpass the 5% mark. This suggests that new bearish positions are the driving force behind the selloff, rather than profit-taking on bullish bets. Despite some profit-taking following the release of inflation data, bearish sentiment remains dominant, with traders adding to their short positions after a higher-than-expected reading for the Fed’s preferred wage gauge.
According to Kaminski, the short signals that emerged in February have materialized into a significant breakout in the market, reinforcing the attractiveness of bearish positions. As traders brace for a potentially hawkish pivot from the Federal Reserve, the bond market is witnessing a resurgence in short bond exposure and a shift towards bearish sentiment.
