The market for Treasurys is one of the deepest and most straightforward in the world, but a big divide has opened up between how different kinds of investors trade it.
Underneath, though, there may be more agreement than there seems.
Since June last year, an apparent rift has emerged between institutional investors and speculators: So-called “leveraged funds”—hedge funds and algorithm-based traders—have accumulated heavy positions against U.S. government bonds, whereas mutual and pension funds are taking the opposite view.
Last Friday, data on futures contracts from the U.S. Commodity Futures Trading Commission showed the highest net buyer position in U.S. Treasurys among asset managers since 2015. Leveraged-fund positioning also recently hit a five-year record, but in this case on the seller side.
Meanwhile, 10-year Treasury yields, which move in the opposite direction to prices, have dipped below 1.6% again.
While Treasury prices can be temporarily affected by factors such as demand for haven assets, they are essentially bets on where the Federal Reserve will set interest rates in the future. And the Fed is constantly communicating to investors what it is likely to do next, so it is rare to see huge divergences of opinion.
If asset managers overall wager that bond yields will fall, someone else needs to take the other side of the trade.
Photo: M. Spencer Green/Associated PressAn easy answer to this riddle is that hedge funds don’t actually disagree that much, and are simply reacting to what others are doing.
If asset managers overall wager that bond yields will fall, someone else needs to take the other side of the trade. This role is traditionally played by banks, also called “dealers,” but leveraged funds can do the job too—for a good price. CFTC data spanning 14 years show that, in the Treasury futures market, the behavior of speculators almost exactly tracks that of banks.
Hedge funds likely aren’t really betting against Treasurys because they have a strong conviction that rates will surge, but simply because they can sell Treasury futures at bargain prices, given the outsize demand of asset managers to buy them.
Importantly, hedge funds can use these trades to finance or protect other parts of their portfolio. Analysts at Société Générale note that they have taken large bets on U.S. small-capitalization stocks and emerging-market assets. Other types of instruments used to bet on rates don’t show this divergence of views between investors.
Asset managers’ hunger for long-dated Treasurys started being reflected in the CFTC figures in 2016 and grew steadily even as the Fed was raising rates. This appears to reflect the widespread—and likely correct—view that borrowing costs won’t go up much in a world where subdued inflation and weak economic growth appear to be structural and deeply-rooted. Worries about the global economy, trade tensions and, lately, the spread of the coronavirus, have further fueled their appetite for Treasurys.
But this stance isn’t risk-free: Even if bonds are unlikely to sell off dramatically, they have a record of making small retreats. Yields are close to the 1.5% level that has historically served as a floor, and Friday’s jobs report confirmed that the U.S. economy remains strong.
Ironically, signs of disagreement between institutional and hedge funds could instead point to a strong consensus among the biggest investors that bond prices can’t go down. If there is a selloff, few will be expecting it.
Write to Jon Sindreu at jon.sindreu@wsj.com
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February 10, 2020 at 07:13PM
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