Professional speculators with billions in bearish trades on the line endured a rough ride after Tuesday’s report on US consumer prices brought the latest sign that the Federal Reserve is making progress in its battle against inflation.
Hedge funds that had amassed the biggest short position against Treasuries since March 2020 were caught off-guard when data showing prices rose at the slowest pace in more than a year sparked a rally across the curve. The two-year rate sank more than 15 basis points.
Funds that kept equity exposure at historically low levels or outright bet against the market with short positions fared slightly better, though not without some drama. The S&P 500 spiked nearly 3% in the report’s aftermath before giving back most of the gains as attention turned to Wednesday’s Fed rate decision.
“Investors have been reluctant up until today’s US CPI release to abandon short positions in rates, this might change now that we have had two consecutive months of significant negative surprises in US core CPI,” said JPMorgan Chase & Co. strategist Nikolaos Panigirtzoglou.
The extreme positioning threatens to undo gains for funds that have ridden the inflation trade all year should the Fed turn less hawkish after its final meeting of the year.
Fast-money quants known as Commodity Trading Advisors were still sitting on underweight Treasuries at historically high levels, the latest data from Wall Street banks showed. Including Tuesday’s sharp move in yields, CTAs could be forced to buy $21 billion of government bond futures this week, according to an estimate from Scott Rubner, Goldman Sachs Group Inc.’s managing director.
Should bonds continue to rally, that could lead to up to $177 billion of purchases over the next month, his model tracking various markets suggests.
Fast-money quants, winners in a market laid low by rampant price pressures, are among those investors with much at stake in any brewing market regime shift. Tuesday’s losses follow their worst month in this year with the Societe Generale CTA Index heading for its worst two months since 2018.
“Given the recent positive momentum in bonds the CTAs should be cutting their shorts,” said Parag Thatte, a strategist at Deutsche Bank. Risk-parity funds that follow cues from falling volatility may soon join them, he said.
Leveraged traders dominated by hedge funds have been betting that aggressive rate policy wouldn’t slay inflation anytime soon. They’d amassed a $90 billion short bet on two- and five-year Treasuries alone, according to JPMorgan.
The picture was less clear in the stock market, where the question is whether the Tuesday advance puts material pressure on investors who have broadly slashed equity exposure. One way to chase gains is via options. Trading in bullish calls increased Monday heading into the CPI release, prompting market makers on the other side of the transactions to short stocks and maintain a market neutral position.
“Overall market positioning is light, so I think you had investors afraid of missing a rally,” said Danny Kirsch, head of options at Piper Sandler & Co. “So with all the call buying, and the light CPI print, perhaps you have dealers short calls, forced to cover on move up, adding a bit of fuel to the move higher.”
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