LONDON (Reuters) - The direction fast money is flowing at the start of the year could not be clearer as hedge funds and speculators ramp up their bets on a lower dollar and higher U.S. bond yields.
Most of these bets are currently in the money. The dollar hit a three-year low on Monday, the 10-year Treasury yield last week rose to its highest since March, and the two-year yield is its highest since 2008.
But as U.S. currency and yields hit levels not seen in years, the size of bets needed to get them there is also growing. Many of these positions are getting stretched, in some cases close to record levels, casting doubt on how much more they can expand and therefore keep the current trends intact.
Data from the Chicago Futures Trading Commission show that hedge funds’ and speculative accounts’ short dollar position against a basket of major and emerging currencies virtually doubled in the week to Jan. 9, to $10.1 billion from $5.4 billion.
That is the largest net short dollar position since the end of October last year.
The U.S. currency is on the slide, hitting a three-year low on a trade-weighted basis on Monday. It fell 10 percent last year, its worst year since 2003, but the New Year has brought no cheer - it’s down a further 1.8 percent in just two weeks.
Most of the FX market’s bearish view on the dollar is rooted in its bullish view on the euro. Net long euro positions leapt to a new record 144,691 contracts from 127,868, according to CFTC. That’s a $21.5 billion bet that the euro will strengthen.
No doubt about it, the euro is on the march as investors bring forward estimates of when the ECB will end its stimulus and start tightening policy. With the euro zone economy booming and oil at $70, inflationary pressures could make that sooner than previously thought.
The euro is at a three-year high just below $1.22. But in 2007, the last time CFTC euro long positions were at record levels, the euro was trading around $1.35 on its way to a record high above $1.60 a year later.
Can the euro go on a similar run this time around? That might be difficult given how heavily fast money is betting on higher U.S. interest rates and bond yields.
The latest CFTC data show hedge funds and speculators doubling down on short Treasuries positions, from short-dated two-year bonds out to longer-dated 10-year bonds.
Net short two-year Treasury futures positions rose to 267,622 contracts from just under 238,000 the week before. That’s the fourth largest short position since CFTC began compiling the data 20 years ago.
The previous three records were all registered since last summer. Since September last year the two-year yield has been marking successive post-crisis peaks, breaking above 2 percent last week for the first time since September 2008.
It’s a similar story with five-year Treasury futures. The CFTC net short position rose to 443,765 last week, the third biggest on record.
The net short position in 10-year Treasury futures grew to 196,853 contracts, the largest since March last year. There have only been six bigger weekly position swings toward bearish bets in the last decade, and only 10 in the last two decades.
This shows speculators are positioning for higher U.S. interest rates and bond yields. The U.S. economy continues to hum along at a decent clip and the Fed seems committed to raising rates further.
How much longer the economic cycle (already long in the tooth) can run and how much higher U.S. rates can rise are, of course, two of the most crucial questions upon which the direction of world financial markets rest this year.
For now, at least, fast money is telling us the dollar will fall further and U.S. bond yields will continue to rise.
(The opinions expressed here are those of the author, a columnist for Reuters)
Reporting by Jamie McGeever; Editing by Toby Chopra