Well as noted on Monday evening, the debate is heating up as to what we’re supposed to make of recent shifts in Treasury spec positioning.
We’re staring down a net long in the 10Y that’s the most extreme since December 2007, and as Deutsche Bank’s Aleksandar Kocic wrote over the long weekend, that probably means exactly what it usually means. Namely this:
Typically, excessive overweight implies subsequent sell off and vice versa. Spec positioning data, both levels and changes, is a contrarian indicator of subsequent rate changes.
That said, even if we do get bear steepening from here (which is what Kocic implied), it’s probably safe to say that the rapid short-covering we’ve seen over the past several weeks reflects extreme skepticism towards the Trump reflation meme.
On Tuesday, Bloomberg’s Cameron Crise is out with some color on the same subject and while there’s not a whole lot that’s new in what you’ll read below, this is something you should keep a close eye on especially as we get ready for what everyone assumes will be another hike.
It has taken four months, but we can officially lay the euphoria of the Trump reflation trade to rest. Speculators have now gone long duration across the Treasury futures curve, according to CFTC data.
While it is tempting to extrapolate more buying into the future, traders may find it more remunerative to look for something other than a monotonous grind lower in the level of yields.
- While much discussion of fixed-income positioning tends to focus on the 10-year part of the curve, I prefer to look across the gamut of maturities to get a more complete picture. On a duration-weighted basis, speculative Treasury futures positioning has gone long for the first time since last summer…and a mere four and a half months after registering record shorts.
- It probably isn’t a coincidence that the short covering started around the time of the March Fed meeting. Although the FOMC hiked rates, the accompanying projections — particularly the infamous dot plot — disappointed some of the more aggressive market expectations.
- Given recent disappointments on the growth and inflation front, is it possible for the FOMC to ratchet its forecast profile lower once again, thus capping yields? Of course it is possible…but given the recent position shift, particularly in 10-year futures, I would argue that a lot of that is probably in the price.
- What I find interesting, however, is the dispersion of positioning across the curve. Speculators have their longest positions in 10-year futures since 2007…but their short position in ultra bonds remains near a record as well. Indeed, plotting normalized speculative futures positioning reveals readings of close to two standard deviations or more in 10s (long), fives, and ultras (both short).
- This in turn suggests that the real opportunity in the Treasury market may entail betting on the curve and for positions to converge on zero. While the 5-10-30 butterfly is above last year’s lows, at -20 bps it is at levels that have proven supportive for much of the last 15 years.
- Of course, the curve itself usually trades with a directional tilt, so perhaps making a call on the direction of yields is unavoidable. Still, when confronted with a choice of positioning for mean reversion or extremes to get more extreme, given the current level of market uncertainty I’ll choose the first one every time.