Hedge Funds

Commentary: Hedge funds double down on curve flattening, bearish dollar bets

LONDON (Reuters) - Hedge funds have found it hard to make money this year trading bonds and currencies, but as 2017 draws to a close they look to be relying on a twin strategy to put a gloss on the numbers: U.S. yield curve flattening and dollar weakness.

U.S. Dollar banknotes are seen in a box at the Money Service Austria company's headquarters in Vienna, Austria, November 16, 2017. REUTERS/Leonhard Foeger

If recent moves in Treasuries and the dollar are any guide, it’s a winner. The U.S. yield curve is the flattest in over a decade and the pace of flattening lately has been dramatic, while the dollar has fallen three straight weeks, its longest losing streak since July.

The latest data from the Chicago Futures Trading Commission show that speculators have increased their net long positions in 10-year Treasuries and short positions in shorter-dated bonds, and increased their bets on a lower dollar for the first time in two months.

Traders are betting on higher short-dated yields in anticipation of further rate rises from the Federal Reserve, but predicting that longer-dated yields will be capped by low inflation and soft growth.

The gap between two-year and 10-year U.S. bond yields, the benchmark measure of the yield curve, narrowed to 56 basis points on Monday, the flattest in over a decade.

The yield curve was around 85 basis points only a month ago, so the current pace of flattening suggests it could invert early next year. Every time the curve has inverted over the past 40 years recession has followed soon after.

Will it be different this time? There’s no obvious reason why the curve is so flat or flattening so rapidly right now with the economy growing steadily around 2.5 percent and close to full employment.

Whether hedge funds and speculators believe a slowdown or even recession is around the corner is immaterial. What they are doing is seizing on a trend and squeezing as much out of it as they can before they close their books for the year.

The CFTC data to the week ending November 21 show that speculators upped their net short two-year Treasury bond positions by 28,646 contracts to 227,294, and their net short five-year Treasuries positions by more than 75,000 contracts to 311,268.

Both show a shift back towards the record net short positions recorded only a few weeks ago - 312,453 contracts in two-year bonds and 469,845 in five-year notes.

Yields on every U.S. bill and bond out to three years are currently the highest since late 2008, when they were plunging to record lows in response to the raging global crisis. The five-year yield is only a few basis points from a new nine-year peak.

It’s a different story with the 10-year yield, which has failed to take out the high from March around 2.60 percent. As recently as September it looked like it would break below 2 percent, but is now hugging the 2.35 percent area.

The flattening yield curve dovetails with the dollar’s failure to gain traction following a period of consolidation over September and October. The greenback’s 20-month low in early September is now back on the radar.

The dollar has reversed all its gains from October and is on course for its worst month since July. The last time it weakened four weeks in a row was April.

The latest CFTC data show that the value of speculators’ net short dollar positions against the yen, euro, sterling, Swiss franc and Canadian and Australian dollars jumped to $3.15 billion in the week to Nov. 21 from $643 million the week before.

In a wider measure of dollar positioning that includes net contracts on the New Zealand dollar, Mexican peso, Brazilian real and Russian ruble, speculators’ net short position more than doubled to $5.23 billion from $2.41 billion.

It’s been a tough year for macro hedge funds trading bonds and currencies. Macro strategy hedge funds are up 3.5 percent year to date, the worst-performing of six strategies tracked by London-based research firm Preqin.

Reporting by Jamie McGeever; Editing by Raissa Kasolowsky