Bearish trades in the US Treasury market are becoming increasingly crowded.
Over the past several weeks, open interest in 5-year and 10-year Treasury futures has continued to climb, with traders betting that yields will push even higher from multi-year peaks.
But that also leaves open another possibility: if economic data suddenly weakens, or Federal Reserve officials signal a dovish stance, the large accumulated short positions could unwind quickly and drive yields sharply lower in the short term.
This week's PCE inflation and nonfarm payrolls data will serve as key catalysts.
The market first awaits the PCE reading, the Fed's preferred inflation gauge, due on Wednesday, followed by the September nonfarm payrolls report on Friday. Economists expect job growth of about 90,000, well below the surprise 162,000 gain in August.
Treasury Shorts Keep Building
Chicago Mercantile Exchange (CME) data show that open interest in 5-year Treasury futures rose on 11 of the past 12 trading days, while the 10-year contract increased on 13 of the past 14 sessions.
In the week through September 22, asset managers added more than 100,000 short positions in 10-year US Treasury futures, one of the largest weekly increases since 2023.
Bank of America strategists including Meghan Swiber wrote in a report: "Futures positioning remains skewed toward higher yields, and shorts remain profitable in the short and intermediate maturities."
They said asset managers continue to add shorts in intermediate- and long-dated Treasuries, while trend-following by commodity trading advisors also shows they are "resolutely short US Treasuries."
Since early last week, the combined new futures risk exposure across the 5-year and 10-year maturities has been about $32 million per basis point, equivalent to roughly $75 billion in current 5-year cash Treasuries.
Beyond directly betting on rising yields, these trades may also include basis trades against cash Treasuries and hedging by asset managers for bond portfolios.
The more concentrated the shorts, the greater the volatility could be when the market reverses.
If jobs data come in significantly weaker than expected, or Fed officials send a more dovish signal, short covering could push yields sharply lower.
30-Year Treasury Yield Climbs to Highest Since 2002
Meanwhile, the selloff at the long end of the Treasury curve is still intensifying.
The 30-year Treasury yield broke above 5.61% on Tuesday, rising for a sixth straight session and touching its highest level since 2002.
Inflation pressures, higher energy prices and a heavy wave of corporate bond issuance are all adding pressure on long-dated Treasuries.
Paramount Skydance Corp. launched an investment-grade bond sale of about $32 billion, which also became a supply factor in focus that day.
Sumitomo Mitsui Banking Corporation (SMBC) rates strategist Monty Gandhi said this was the fifth-largest investment-grade bond trade on record, and "part of the move at the long end may be related to that."
The US Treasury market is about $32 trillion in size and has fallen 2.6% so far this year, after gaining 6.3% last year.
The 10-year yield is currently around 5.25%, near its highest since 2007; the 2-year yield is the last major maturity still below 5%.
Michael Cloherty, head of US rates strategy at CIBC Capital Markets, said long-dated Treasuries already look cheap by historical standards, but high yields still have not attracted a large wave of value buyers.
"We have been waiting for more than a month, and they are absent," Cloherty said.
Rate-Hike Expectations Battle Jobs Data
Higher energy prices had led the market to bet on further Fed rate increases, pushing Treasury yields higher.
The market at one point expected at least a 25 basis point hike by year-end, possibly as early as the October meeting, and nearly three more cumulative hikes through mid-2027.
But comments from New York Fed President Williams on Tuesday cooled some of those expectations.
He said that to curb inflation, "one more increase" in the Fed's target range later this year "may be appropriate."
The 2-year Treasury yield, which is more sensitive to policy expectations, fell as much as 5 basis points after Williams spoke before stabilizing around 4.89%.
Dan Carter, senior portfolio manager at Fort Washington Investment Advisors, said Williams' remarks formed a "fairly stark contrast" with "many other Fed speakers," who had previously conveyed a sense of urgency about further hikes.
Carter believes market bets on an October hike may hold at least until Friday.
That is when the September US nonfarm payrolls report will be released.
Economists expect payrolls to rise by about 90,000 in September, down from 162,000 in August.
If the data are significantly weaker than expected, the current crowded short positions in Treasuries will face repricing.
October Still Faces Supply and Seasonal Pressure
Beyond monetary policy, the size of US government debt, corporate financing needs and the unwinding of yen-funded carry trades are also affecting the Treasury market.
Citigroup strategists believe carry trades that borrow in yen and invest in higher-yielding assets are being unwound and driving Treasury selling.
Yardeni Research also sees the unwinding of yen carry trades as one of the drivers of the recent bond selloff.
But some investors are already seeing the opposite opportunity.
Wall Street investor Jim Bianco turned bullish on Treasuries for the first time in six years, while long-term bond investor Chris Iggo believes bonds may rebound after four consecutive difficult years.
Mark Dowding, chief investment officer at RBC BlueBay Asset Management, believes the global bond market selloff has gone too far.
Seasonal factors may also keep pressure on the Treasury market in October.
Bloomberg data show that over the past 10 years, US Treasuries posted a median decline of 0.9% in September and 0.7% in October.
TD Securities strategist Prashant Newnaha said: "The September rates market was nothing short of a disaster, and the pain trade may continue."
He noted that as long as the situation in the Middle East remains unresolved, the fixed income market still faces the possibility of continued de-risking.
Masahiko Loo, senior fixed income strategist at State Street Investment Management, said October is usually a "seasonal test period" for US Treasuries.
As investors return to the market after the summer lull, new Treasury supply, heavy credit issuance and AI capital expenditure demands will continue to compete for limited capital.
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