With the non-farm payroll report coming out on Friday, the market appears to be preparing for bear steepening (rising long-term rates) by increasing the net short position on short term U.S. Treasuries and increasing the net short on 10 year US Treasury bonds, though there is a marked difference between flows from different types of investors.
Recent net long hasn’t dented overall U.S. Treasuries short
“Over the last month, investors have doubled their net long at the front end. While this may reflect increased faith in lower policy rates for longer (as well as flight to quality) the increase in the short in 10s suggests that this the market as a whole is in little doubt about the ongoing withdrawal of liquidity,” writes Citi analyst Robert Crossley.
The flight to quality that Crossley mentions (largely due to outflows from emerging markets) didn’t change the market’s net short on U.S. Treasuries, which has been concentrated in 10 year bonds with 5 and 15 year bonds being slightly less short. Even over the last month, investors have been net selling 10 year bonds.
Treasuries Banks turn bullish as hedge funds, real money sell
Breaking down net exposure by client type reveals a serious difference of opinion about what to expect. Real money, such as mutual funds and pension funds, had been increasing their long positions before turning bearish and reducing those positions to more typical levels over the last two weeks. Hedge funds have also become more bearish, increasing their short positions recently, while banks have reversed course and are now long on Treasuries after months of being short.
It’s not clear why different classes of investors would move so clearly against each other, and Crossley doesn’t speculate on the difference in reasoning.
Since the end of January, 10 and 15 year bonds have been moving roughly in tandem, but 2 and 5 year bonds had been uncorrelated until recently. Just as investors started to change their tune (though not all in the same direction) the 2 and 5 year bonds started mirroring each other with short interest in one reflecting long interest in the other. Therefore, regardless of what the data looks like on Friday, investors don’t see the Fed surprising by tightening policy.
“While duration is being shortened, there seems to be little fear of policy rate hikes being brought forward. A strong NFP could really put the cat amongst the pigeons at the front end,” writes Crossley.