Hedge funds built up record shorts on futures
An expected surge in Treasury bill issuance could throw a wrench into the gears of hedge fund trades that have resulted in record short positions, potentially disrupting bond markets if speculators quickly unwind their holdings.
“This could be one risk to that kind of trade developing that forces a lot of these funds to close these basis trades and then create shock waves throughout the market,” said Gennadiy Goldberg, head of U.S. rates strategy at TD Securities USA. “Less liquidity could mean a shift in the supply and demand of the repo market,” with hedge funds potentially facing higher rates just because there is less cash in the system to lend, said Steven Zeng, U.S. rates strategist at Deutsche Bank.
But some analysts fear bank reserves could decline if the Treasury bills do not offer higher returns than the RRP or if expectations of more interest rate hikes discourage money funds from extending the duration of their investments. Commodity Futures Trading Commission data at the end of May showed speculators’ bearish bets on U.S. Treasury two-year, five-year, and 10-year bonds had grown to their largest ever. Some of those shorts have been scaled back, but net shorts on two-year notes hit a new record in the week ending June 13.
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