Look, here’s the thing: spec positioning in the front-end is extreme.
And by “extreme” I mean record short.
If you’re the type of person who likes to stick around on Friday evenings for the CFTC report, you know that the latest data showed specs upping their net TU short by 17K contracts after taking a brief breather during the previous week.
If you look at the chart, net shorts in TU have grown by something on the order of 263K contracts since May:
Now apparently, this is confusing the shit out of some folks, because after all, no one save maybe an increasingly irritated Richard Breslow, thinks the Fed is going to signal anything notable on Wednesday.
“The mindset of the market is that inflation continues to disappoint the Fed — most people think the Fed is on hold for the rest of the year, to be honest,” Charles Comiskey, head of Treasuries trading in New York at Bank of Nova Scotia, told Bloomberg, adding that “being short the two-year note here just doesn’t make sense.”
But really, this needn’t be some kind of vexing quandary.
For one thing, if you look at positioning in TY, this could just amount to a bet on a flatter curve. This is something we noted weeks ago after the difference between TU and TY net positions ballooned:
But there may be a simpler answer still: notably that the 2Y is simply too damn rich.
“We do not think the positioning in TU is a macro or a Fed story. Instead, we believe the richness of the 2-year explains the record spec short positions,” Deutsche Bank wrote, in a note to clients this afternoon. The bank continues:
Check out where CT2 is trading versus fed funds in the chart below. On 3/14, before the first rate hike of this year, 2yr yield was 75 bps higher. Right now it’s 26 bps. Incredibly, two Fed hikes have failed to budge 2yr yields by even the smallest amount.
Looking at RV on the curve, the 3m-2y-5y butterfly tells the same story: that 2yr is rich. In fact, the butterfly spread is at its lowest level since September 2015, when the market was bracing for this cycle’s very first rate hike (but didn’t get it until December that year). Perhaps because the Fed had waited, the 3m-2y-5y butterfly cheapened to +20 bps by the time Fed had lift off. But all that cheapness is gone now.
Or, here’s another idea: where do you think all of these folks went?…
In any event, sometimes Occam’s razor is the best answer when presented with an apparent “mystery.”