ORLANDO, Fla. – Hedge funds have started 2023 betting that US interest rates are close to peaking, that the Federal Reserve will keep them higher for longer and that the dollar will weaken slightly.
Judging by the economic data, financial market swings and talk from US policymakers in the first week of the year, this would appear to be a reasonable – and reasonably consensus – macro strategy to employ.
At least for now.
Commodity Futures Trading Commission (CFTC) data show that speculators closed 2022 with one of the smallest three-month SOFR rate futures short positions of the year, a light short dollar position, and substantial short positions cross the US Treasuries curve.
A short position is essentially a wager that an asset’s price will fall, and a long position is a bet it will rise. In bonds and interest rates, yields and implied rates fall when prices rise, and move up when prices fall.
CFTC speculators increased their net short position in three-month Secured Overnight Financing Rate (SOFR) futures to 175,218 contracts in the week through January 3, but that is still one of the smallest net short positions of a tumultuous year.
Funds’ US interest rate expectations reached fever pitch around August and September last year when their net short position exceeded 1 million contracts.
The rapid reversal since then shows they are much more neutral on the rate and inflation outlooks this year and think the Fed is close to ending its hiking cycle, or they have taken profit on a highly lucrative trade. Or both.
“The bottom line is that the Fed and the consensus are right to expect a decline in inflation as we go through 2023,” reckons Torsten Slok, partner at Apollo Global Management in New York.
Hedge funds are on track for their worst returns in 14 years in 2022, but macro strategies have performed much better. Industry data provider HFR’s macro index was up 8.15 percent in the first 11 months of the year, and the currency index was up 12.58 percent.
HFR is expected to release its December and full-year 2022 returns figures this week, and industry peer Preqin will follow later in the month.
CFTC speculators’ small wager on short-term US rates stands in contrast to the substantial bets they still retain against two- and 10-year Treasuries, even though the end of the Fed’s hiking cycle and economic slowdown are both coming into view.
In the 10-year space, funds ended 2022 with their third largest net short position of the year, at 383,602 contracts. Funds have been short these futures since October 2021, and the selling bias has strengthened recently – pullbacks have been quickly followed by weeks of even larger bearish bets.
Since hitting a 15-year high of 4.30 percent in October the 10-year yield has fallen; it closed at 3.57 percent on Friday. The yield curve inversion deepened in that time too, meaning the 10-year yield fell further below the two-year. – Reuters
