The U.S. Treasury market is witnessing a broad capitulation among bullish investors. According to Bank of America's latest research report on May 19, long positions across the Treasury yield curve have largely surrendered, leaving only minimal residual out-of-the-money (OTM) holdings. In contrast, short positions now dominate overwhelmingly and are mostly in-the-money (ITM).
The bank's U.S. rates research team noted in its "U.S. Rates Watch" report that various capital sources, from systematic trend followers (CTAs) to global active asset managers and Japanese private and official investors, are simultaneously adjusting their positions—either exiting or shorting U.S. Treasuries.
Commodity Trading Advisors (CTAs) have stretched their short positions to the limit. Asset management institutions continue to increase shorts or unwind long positions. Japanese private investors have been net sellers of U.S. Treasuries for two consecutive months. Furthermore, potential yen intervention operations could introduce an implicit selling pressure of $40 to $50 billion.
Behind this significant position reshuffle, however, rising yields are attracting a frenzied flow of capital back into the short end and credit markets. Meanwhile, analysis suggests the "Sword of Damocles" hanging over the market is the potential for large-scale foreign exchange intervention by the Bank of Japan. If intervention escalates and triggers official sales of U.S. Treasuries, the global fixed income market could face a genuine storm.
**CTA and Asset Managers Pivot Fully, Short Positions Approach Limits** The reversal in market positioning is exceptionally sharp. Data from BofA's systematic strategy team shows that CTA short positions across the entire yield curve have reached their limits. In recent weeks, the focus of shorting has shifted from the front end to the long end. Future changes in positioning will depend heavily on volatility: if futures continue to decline amid falling volatility, short positions may expand further; however, if volatility rises, a pullback in shorts is anticipated.
Concurrently, global asset managers are rapidly shortening duration. Last week, asset managers primarily increased shorts or closed long positions. Net shorts increased across all maturities except for the 20-year (US) and 30-year (WN) Treasuries. Active benchmark aggregate funds (Agg funds) are currently "underweight" U.S. Treasuries while remaining "overweight" mortgage-backed securities (MBS) and investment-grade (IG) bonds.
The most significant change over the past month has been the rising overweight allocation to investment-grade bonds. This spread overweight strategy has supported active funds' outperformance relative to U.S. Treasuries since early April.
**Japanese Capital Continues Retreat, Shadow of Trillion-Dollar FX Intervention Looms** The dynamics of foreign investors add another layer of significant risk to the U.S. Treasury market, particularly the movements of Japanese capital. Data from Japan's Ministry of Finance (MoF) shows that after selling $18 billion in February, Japanese private investors were net sellers of another $14 billion in U.S. Treasuries in March. Banks led the selling, with pensions and life insurance companies also actively participating.
The core reason is that for Japanese investors, even after a 3-month rolling FX hedge, the yield on 10-year U.S. Treasuries compared to Japanese Government Bonds (JGBs) remains deeply negative (e.g., -2.09% spread versus 20-year JGBs).
More concerning for the market is the potential for official Japanese foreign exchange intervention. BofA FX strategists estimate that recent suspected yen-supporting intervention likely involved around $72 billion (potentially the largest since 2022). This implies a potential hidden selling pressure on U.S. Treasuries of $40 to $50 billion.
Although data from the Federal Reserve's foreign reverse repo (RRP, an official cash proxy indicator) and custodial holdings as of the week ending May 13 do not yet show clear evidence of large-scale official liquidation (custodial holdings only declined moderately by $10 billion compared to pre-intervention potential), the source of intervention funds remains a mystery.
BofA warns that if further yen intervention required selling nearly $100 billion in U.S. Treasuries, it would have a material impact on the Treasury market. This scale would be equivalent to the decline in custodial holdings seen at the onset of the Iran conflict and would pose significant headwinds for front-end spread positions.
**Soaring Yields Trigger Capital Migration, Short Duration Becomes Absolute Safe Haven** Despite the overall bearish positioning, capital flows reveal market tension from another dimension: higher yields are re-attracting capital inflows. As duration is being sold off, fund inflows have actually accelerated. Last week, U.S. fixed income funds attracted a substantial $18 billion, double the average of the past 12 weeks.
However, capital is not flowing in blindly. Inflows were primarily led by aggregate (Agg), short-term government bond, and investment-grade (IG) bond funds. Long-term government bond funds were the only category to experience outflows.
This significant divergence indicates that investors are rapidly shortening their weighted average maturity (WAM) as the market reprices Federal Reserve rate hike risks.
Notably, against the backdrop of long retreat and foreign selling, primary dealers and domestic U.S. banks are absorbing the supply. Data shows dealers' balance sheets are expanding, with their long-end holdings in cash and futures markets increasing significantly. Meanwhile, domestic U.S. banks have accelerated their purchases of U.S. Treasuries and agency bonds (UST & Agency) in recent months, outpacing their purchases of MBS.
Additionally, the traditional large buyer in the fixed income market—defined benefit private pensions—currently remains in a healthy funding position (the Milliman index indicates they are well-funded). Historical experience suggests pensions tend to buy more U.S. Treasuries when funding improves and rates rise.
However, April data shows that U.S. Treasury STRIPS (Separate Trading of Registered Interest and Principal of Securities) activity has retreated from its peak at the end of 2024 and is below historical averages. This hints that the momentum from this segment of long-term buying is marginally slowing and is unlikely to fully offset the current selling frenzy.
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