Bond Traders Stare Down Short Squeeze as Yields Test Key Levels

  • U.S. 10-year yield breaks 50% Fibonacci level since election
  • Latest data show short covering picks up in 5-year futures

Bond bears beware -- the risk is building that Treasury yields go even lower.

With yields across maturities reaching the lowest levels since November, and in some cases breaching key technical marks, traders are abandoning bets on higher interest rates. Hedge funds and other large speculators reduced net short positions in five-year note futures by about 86,000 contracts in the week through April 11, though more than double that amount of net shorts remain, the latest Commodity Futures Trading Commission data show.

The trend shows that even the most ardent advocates of higher rates are questioning whether the Treasuries market moved too swiftly in pricing in prospects of quicker growth and inflation. In the latest round of covering, speculators pared shorts to the lowest since the U.S. election. Tuesday’s bond rally, which may have been aided by more bears retreating, underscored the impact of market positioning now that yields have broken out of their 2017 range.

TD Securities strategists said in an April 17 note that they covered their five-year Treasury short at 1.75 percent, near a key Fibonacci retracement level of bond-market movement since the election.

While the analysts still expect the Federal Reserve to hike twice more this year, weaker U.S. economic data and international tension involving Russia and North Korea leave them seeing better opportunities to resume the wager in coming weeks.

“This generally disappointing tone has led investors to pare back broader short Treasury positioning, with short-covering pushing yields sharply lower,” they wrote. “We will look to re-engage shorts at more attractive levels as geopolitical concerns recede over the coming weeks.”

JPMorgan Chase & Co.’s weekly client survey for the period ended April 17 showed a decline among all managers in short Treasury positions, matching the lowest level since the election.

For bond bears, there may still be room for a further shakeout. Speculators modestly increased their short position in 10-year Treasury futures and ultra-long contracts, CFTC data through April 11 show.

On Tuesday, the 10-year Treasury yield fell as low as 2.163 percent, breaking through the 50 percent Fibonacci retracement level since the election -- 2.1769 percent. The yield rose to 2.200 percent as of 7 a.m. New York time Wednesday.

“We have yet to see a full capitulation of the short-Treasuries Trump trade,” BMO Capital Markets strategists wrote in a note Tuesday. Some traders added new shorts last week only to be squeezed again, they said.

“It opens the potential for an even more dramatic rally if Trumponomics is truly DOA and domestic equities more significantly correct,” they said.

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