Column: Funds flattened by safety stampede into U.S. bonds, dollar

Traders work on the floor of the NYSE in New York
Traders work on the floor of the New York Stock Exchange (NYSE) in New York City, New York, U.S., March 3, 2022. REUTERS/Brendan McDermid

ORLANDO, Fla., March 7 (Reuters) - Hedge funds have been completely wrong-footed by the surge in U.S. Treasuries and the dollar sparked by Russia's invasion of Ukraine.

Futures market positioning data show speculators increased their bearish bets on bonds and cut their bullish bets on the greenback, just as both were lifted on a wave of safe-haven inflows.

Hedge funds often risk going against the market consensus to try and maximize returns. But their initial reaction to the conflict unfolding in Europe appears odd, given how likely the safety flight to Treasuries and the dollar was.

Commodity Futures Trading Commission data for the week through March 1 shows funds' net short position in five-year Treasuries increased by 126,803 contracts to 474,039, and their 10-year net short position rose by more than 80,000 contracts to 365,783.

Both are sizeable moves. Indeed, the cumulative increase in the five-year net short of almost 300,000 contracts in the past fortnight is the most bearish two-week move since these contracts were launched in the late 1980s.


Funds are now sitting on their largest bet on a higher five-year yield for nearly three and a half years, and their largest bet on a rising 10-year yield since February 2020.

A short position is essentially a bet that an asset's price will fall, and a long position is a bet it will rise. In bonds, yields rise when prices fall, and move lower when prices rise.


Yet during the week through March 1, which covered the Feb. 24 invasion, U.S. Treasuries rallied across the curve, pushing the five-year yield down by some 30 basis points and the 10-year yield around 25 bps lower.

This was all done on huge volume too. Refinitiv data shows that volume in 10-year Treasury futures in the week of Feb. 21-25 was one of the highest since 2008, and Tradeweb said U.S. government bond average daily volume in February rose 30% on the year to a record $153 billion.

The U.S. economy has relatively little direct exposure to Ukraine or Russia. But the war, and financial and economic sanctions imposed on Moscow, will have a serious impact on Europe especially, and that will drag on global and U.S. growth.

The outlook for U.S. interest rates is also being revised, even though inflation is its highest in 40 years and surging commodity and energy prices could push it even higher. Markets no longer expect a 50-bps rate hike this month and full-year tightening expectations have been lowered to 125 bps from over 150 bps before the invasion.


"Soaring commodity prices and increased risk aversion caused by the Russia-Ukraine war imply a stagflationary shock for the global economy," Barclays economists wrote on Friday, cutting their growth forecasts and raising their inflation outlook.


All of this continues to show up in the relentless compression of the gap between two- and 10-year U.S. yields. The curve is now within 25 basis points of inverting, a move that usually precedes recession.

Funds have mostly been on the right side of the curve flattening trade this year. But some may think it has run its course and are now trying to position for a reversal, either tactically in the short term, or strategically for the long term.

If funds got it wrong on Treasuries last week, their losses were not covered by their bets on the dollar. The CFTC data show speculators reduced their net long dollar position to $3.84 billion from just over $5 billion.

That is the smallest in six months, yet the dollar has been on a tear and has extended its gains since the war broke out. It rose 1.5% against a basket of major currencies in the week through March 1, and almost 1% on the day of the invasion.

The euro, in particular, is getting hit hard, and Deutsche Bank even said the European Central Bank might have to intervene soon to hold it up. read more

"With safe-haven flows likely to continue for sometime yet and Fed officials eager to press on with their policy normalization plans, 100+ for (the dollar index) is just a matter of time," Westpac FX analysts said on Sunday.


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

By Jamie McGeever; Editing by Chris Reese

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Jamie McGeever has been a financial journalist since 1998, reporting from Brazil, Spain, New York, London, and now back in the U.S. again. Focus on economics, central banks, policymakers, and global markets - especially FX and fixed income. Follow me on Twitter: @ReutersJamie