Short positions in US Treasury futures have continued to build, and analysts believe that if economic data weakens or Federal Reserve officials send dovish signals, the market could face sharp short covering.
According to reports, weighed down by a surge in corporate bond supply, US Treasuries extended their months-long decline on Tuesday, with the 30-year Treasury yield rising to its highest level since 2002. At the same time, elevated energy prices continued to increase inflationary pressure, further fueling bearish sentiment in the market.
However, US Treasury futures short positions are now highly concentrated, and any unexpectedly cooling economic signal could trigger a rapid unwind of short positions, causing a sharp short-term decline in yields.
This week, bond traders will focus on two key data releases: the Fed's preferred inflation gauge due on Wednesday, and the monthly employment report at the end of the week. Economists surveyed by Bloomberg expect nonfarm payrolls to rise by about 90,000 in September, a sharp slowdown from the unexpected 162,000 increase in August.
Short positions accumulate rapidly, with positioning hitting a new phase high
According to CME data, open interest in 5-year and 10-year Treasury futures has risen sharply over the past roughly two weeks.
According to US Commodity Futures Trading Commission data, in the week ended September 22, asset management institutions added more than 100,000 new short positions in 10-year Treasury futures, one of the largest weekly increases since 2023.
In addition, 5-year contracts saw position increases in 11 of the past 12 trading days, while 10-year contracts expanded for 13 of the past 14 trading days.
In terms of scale, since the start of last week, the combined new futures risk exposure in the two maturities has been about $32 million per basis point, equivalent to $75 billion in current 5-year cash notes.
Bank of America strategists including Meghan Swiber said in a research note:
Futures positioning still leans toward further yield increases, and in the short- and medium-term maturities, short positions are currently still profitable.
The team also noted that asset management institutions continue to increase Treasury shorts, especially concentrated in medium- and long-term maturities, while trend signals from commodity trading advisers also show they are "firmly maintaining short positions in US Treasuries."
It is worth noting that behind the current increase in positions, aside from directional shorting, there may also be basis trades against cash Treasuries, or hedging operations by asset management institutions against bond holdings, which to some extent increases the complexity of the market structure.
Short-covering risk rises, options market already shows signs of hedging
As bearish forces continue to accumulate, once economic data comes in below expectations or Fed officials make dovish remarks, the market could face severe short covering, at which point yields may fall rapidly, at least in the short term.
Developments in the options market have already confirmed this concern. According to Bloomberg data, over the past week, the skew in options on long-bond futures contracts changed sharply, with the premium on put options rising to its highest level since August, indicating that traders are actively seeking protection against further yield increases, pushing up the cost of puts relative to calls.
In addition, some bearish hedging positions will expire at the end of this week, meaning these positions also cover the event risk from Friday's nonfarm payrolls data.
At the same time, JPMorgan's Treasury client survey showed that in the week ended September 28, investor positioning remained broadly unchanged, with long positions still at their highest level since last November, indicating that some bullish strength remains and providing a certain foundation for potential short covering.
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