Hedge funds have found it tough to make money this year trading bonds and currencies, but as 2017 brings to a close they seem to be relying upon a twin approach to put a shine on the amounts: U.S. yield curve flattening and dollar weakness.
If recent moves in Treasuries and the dollar are any guide, it is a winner. The U.S. yield curve is the flattest in more than a decade and the speed of flattening recently has been striking, while the dollar has dropped three consecutive weeks, its longest losing streak since July.
The most recent data from the Chicago Futures Trading Commission show that speculators have increased their net long positions in 10-year Treasuries and short positions in shorter-dated bonds, and increased their stakes on a lower dollar for the first time in 2 weeks.
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 gentle growth.
The gap between two-year and 10-year U.S. bond yields, the benchmark measure of the yield curve, narrowed to 56 basis points on Monday, the flattest in more than a decade.
The yield curve was around 85 basis points just a month ago, so the present pace of flattening indicates it could reverse early next year. Every time the curve has inverted over the last 40 years recession has followed shortly after.
Will it be different this time? There is no clear reason why the curve is so flat or flattening so quickly right now with the market growing steadily around 2.5 percent and near full employment.
Whether hedge funds and speculators think a slowdown or even recession is around the corner is insignificant. What they’re doing is seizing on a fashion and squeezing as much from it as they could before they close their books for the year.
The CFTC data to the week ending November 21 show that speculators upped their net short two-year Treasury bond places by 28,646 contracts to 227,294, and their net short five-year Treasuries rankings by over 75,000 contracts to 311,268.
Both show a shift back towards the record net short positions listed just a couple weeks back – 312,453 contracts in two-year bonds and 469,845 in five-year notes.
Yields on every U.S. invoice and bond out to three years are now the highest since late 2008, when they were plunging to record lows in response to the raging international crisis. The five-year yield is just a couple of basis points from a new nine-year summit.
It is a different story with the 10-year yield, which has failed to extract the high from March around 2.60 percent. As recently as September it seemed like it would break under two percent, but is now hugging the 2.35-per-cent location.
The flattening yield curve dovetails with the dollar’s failure to gain traction after a period of consolidation over September and October. The greenback’s 20-month low in early September is back to the radar.
The dollar has reversed all of its profits from October and is on course for its worst month since July. The last time it weakened four weeks in a row was April.
The hottest CFTC data reveal that the value of speculators’ net short dollar positions against the yen, euro, sterling, Swiss franc and Australian and Canadian dollars jumped to $3.15-billion per week to Nov. 21 from $643-million the week earlier.
In a larger measure of dollar placement which includes net contracts on the New Zealand dollar, Mexican peso, Brazilian real and Russian ruble, speculators’ net short position more than doubled to $5.23-billion from $2.41-billion.
It’s been a challenging season for macro hedge funds trading bonds and currencies. Macro strategy hedge funds are up 3.5 percent year to date, the worst-performing of six plans tracked by London-based research company Preqin.