Funds face massacre on record short US rates position: McGeever

ORLANDO, Florida (Reuters) -Hedge funds face huge losses on their record bet that the Fed will go full steam ahead with its aggressive interest rate-raising campaign, after some of the most abrupt and violent swings in U.S. rates and bond market pricing in living memory.

FILE PHOTO: Signage is seen outside of the US Commodity Futures Trading Commission (CFTC) in Washington, D.C., U.S., August 30, 2020. REUTERS/Andrew Kelly

Commodity Futures Trading Commission (CFTC) data shows that speculators held the largest ever net short position in three-month SOFR rate futures in the week ending March 7, only a few weeks after amassing a record short position in two-year Treasuries futures.

Implied rates across the 2023 SOFR curve peaked a day later on March 8, before troubles at Silicon Valley Bank and crypto bank Silvergate emerged on March 9 and sowed the seeds of what rapidly grew into a global banking crisis.

Implied rates then plunged as much as 200 basis points in a week as traders drastically redrew their Fed outlook. The two-year Treasury yield posted its biggest fall since the Black Monday crash of 1987, and U.S. bond market volatility surged the most since Lehman’s collapse.

Trend-following and macro funds, and Commodity Trading Advisors have been badly wrong-footed by the rates reversal, registering up to double-digit losses for the month by early last week, according to banks and traders.

These losses are likely to have increased as rates and yields fell further, exposing leveraged funds to a huge Value at Risk shock. A VaR shock is essentially a rise in the maximum loss an investment can sustain over a period of time.

The latest CFTC data show that funds and speculative accounts increased their net short position in three-month Secured Overnight Financing Rate futures to 1.17 million contracts from 829,000 contracts, surpassing the previous record short of 1.06 million contacts last September.

Only six weeks before, funds held a small net long position.


The CFTC positioning data is lagging by one week, after a cyber attack on the derivatives platform of ION Group which delayed trading firms’ reporting earlier this year.

Analysts at Goldman Sachs noted that trading at the front end of the SOFR curve last week was particularly choppy, reflecting “extremely elevated uncertainty” about the near-term path for U.S. interest rates.

“Liquidity provision has dropped as a result, with market depth declining across the curve, and a sharp increase in the price impact of order flow,” they wrote on Friday.

“Although we continue to believe economic fundamentals warrant a lower rate vol regime, this will be hard to price until the systemic fears fade,” they said, adding that the longer banking system concerns persist, rates volatility is likely to persist also.

Analysts at Deutsche Bank say the huge disconnect between bond and rates volatility over equity volatility recently is partly down to the extreme positioning in fixed income.

The damage to investors of all stripes from the recent level of volatility in short-end U.S. interest rates and bond yields cannot be overstated, and those with direct exposure will be hit especially hard.

Media reports say Adam Levison’s Graticule Asia macro hedge fund has closed after plunging more than 25% this year, mostly since the SVB crisis erupted, as bets tied to short-term rates imploded.

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.

Hedge funds take positions in short-dated U.S. rates and bonds futures for hedging purposes and relative value trades, so the CFTC data is not reflective of purely directional bets. But it is a pretty good guide.

(The opinions expressed here are those of the author, a columnist for Reuters.)

By Jamie McGeever; Editing by Christian Schmollinger