Funds made significant bets on the American curve steepeners McGeever.

The most inverted portion of the U.S. yield curve in a critical area is enough for hedge funds. Speculators are betting that the historical difference between the rates on the 10-year and three-month securities will begin to close, according to positioning data from the Commodity Futures Trading Commission.

Two noteworthy data from the most recent CFTC report illustrate this: the biggest net short position on 10-year Treasury futures since 2018 and the smallest net short position on three-month “SOFR” rate futures in over two years. Together, they indicate a perception that implied U.S. interest rates would climb more slowly or not at all in the upcoming months while 10-year yields will rise.

The remarkable flattening of the 3-month/10-year curve, which last week inverted by as much as 140 basis points, the highest since 1981, could be reversed with the aid of this.

In the week ending January 17, CFTC traders reduced their net short position in three-month Secured Overnight Financing Rate (SOFR) futures to just 9,077 contracts. considering that it is the smallest net short since December 2021 Early in September, the short position reached 1 million contracts; it is now almost neutral.

The largest long since August, the funds’ one-month SOFR net long position now stands at over 67,000 contracts. Since late 2020, momentum indicators are now at their most optimistic. The CFTC figures do not accurately reflect solely directional bets because hedge funds hold holdings in short-dated U.S. rates and bond futures for hedging purposes. However, they serve as a decent guide.

A short position is essentially a bet that the price of an asset will decrease, whereas a long position is a bet that the price will increase. Bond yields and implied rates decrease when prices increase and increase when prices decrease.

In the meantime, traders increased their net short position in 10-year Treasury futures by 133,699 contracts to 545,000 contracts, which is the largest weekly change since last October.

Since October 2018, that is the biggest collective wager against 10-year bonds and in favor of higher yields. But if the incoming U.S. economic data is any indication, a steeper yield curve is unlikely to be caused by a higher 10-year yield from a fundamental economic standpoint.

Data from purchasing managers in the services and manufacturing sectors, regional manufacturing indices, and consumer mood indicators are all at levels commonly linked with previous recessions.

An indication that investors anticipate GDP and inflation to deteriorate to the point where the Federal Reserve will eventually have to loosen policy is the fact that longer-dated borrowing costs have fallen considerably below short-term yields.

But from a tactical standpoint, it makes more sense. The tightening that has been priced into the upcoming Fed meetings may be losing some of its froth, and traders may also believe that the curve, like a stretched rubber band, must inevitably snap back.

The recent flattening of the 3-month/10-year yield curve, which had a positive slope as recently as October and was about 230 basis points positive in May of last year, is the most striking example.

The case for more rate hikes is still being made by Fed officials, particularly Vice Chair Lael Brainard and Governor Christopher Waller, two of the most significant policymakers after Chair Jerome Powell.

Rate reduction does not appear to be in the Fed’s 2023 plan, but ‘SOFR’ futures continue to assume 50 basis points of easing this year.

The flattening bias, according to many analysts, will continue to rule this year. Although they may fundamentally concur, hedge funds are currently wagering on at least a short-term outcome of steepening phase.