Photographer: David Williams/Bloomberg

Hedge Funds Betting Treasuries Rally Has Further to Run

Updated on
  • Yields rise as Dudley says traders may underestimate Fed
  • Treasury 30-year bonds plunge by most since February

Hedge funds made the biggest bet on benchmark Treasuries in more than three years just as the longest-dated U.S. tumbled and Federal Reserve officials reinforced the potential for an interest-rate hike this year.

In a sign traders are confident a record-setting Treasuries rally has further to run, hedge funds and other large speculators boosted positions in 10-year futures to a net 185,521 contracts last week, the most since December 2012, according to the Commodity Futures Trading Commission’s Commitments of Traders report. 

Their conviction is being tested as Treasuries slipped after New York Fed President William Dudley said investors are underestimating how many times the central bank will raise rates and Dallas Fed President Robert Kaplan said an increase in September is “very much on the table.” U.S. debt extended losses as Microsoft Corp. priced a $19.75 billion bond sale.

“When you see these Fed speakers come out, people are growing increasingly cognizant that the market is positioned in a very long way, which might be inappropriate given the underlying data in the U.S.,” said Jonathan Rick, an interest-rate derivatives strategist in New York at Credit Agricole CIB, which forecasts a Fed rate increase in December.

The retreat for Treasuries follows gains last week after a report showed second-quarter U.S. gross domestic product grew at less than half the pace economists predicted. U.S. manufacturing expanded in July, though at a slower pace, an Institute for Supply Management index showed Monday. Policy makers will hold off raising rates for at least a year, according to fed funds futures data compiled by Bloomberg, while the probability of a hike this year is about 36 percent, down from 48 percent a week ago.

Economic Data

The U.S. 10-year note yield climbed seven basis points, or 0.07 percentage point, to 1.52 percent at 5 p.m. in New York, Bloomberg Bond Trader data show. The price of the 1.625 percent security due in May 2026 was 100 29/32. The yield dropped to a record 1.318 percent last month.

The 30-year U.S. bond yield surged nine basis points, the most in more than five months, to 2.27 percent. Microsoft’s debt sale included securities that mature in 30 and 40 years.

Citigroup Inc.’s U.S. Economic Surprise Index last week reached the highest in almost two years before dropping by the most since January 2013 on July 29, when the GDP data were released.

“The Fed is probably going to delay the interest-rate hike,” said Kim Youngsung, head of overseas investment in Seoul at South Korea’s Government Employees Pension Service, which has $13.5 billion in assets. “The economic data have been mixed. It’s been really good for U.S. Treasuries.”

Though Treasuries rallied after the Fed’s July 27 policy statement on signals that the central bank would continue down a gradual path of rate increases, policy makers since then have cautioned the bond market on its outlook for lower rates.

Payrolls Report

“The movement in investor expectations towards a flatter path for U.S. short-term interest rates seems broadly appropriate,” Dudley said in remarks prepared for a speech Monday at a conference in Bali. However, “it is premature to rule out further monetary-policy tightening this year,” he said.

Traders will focus this week on U.S. data including the Labor Department’s July payrolls report on Aug. 5, after relatively extreme swings in the pace of hiring in the previous two months. The survey will be released as a Merrill Lynch measure of expected price swings in Treasuries has dropped to the lowest level since 2014.

“The underlying demand for bonds remains strong, but I think the rally will run into obstacles this week,” said Jan von Gerich, chief strategist at Nordea Bank AB in Helsinki. “The recent move back in yields leaves the Treasury market vulnerable to upside data surprises, especially regarding Friday’s employment report.”