Hedge funds cool on rate hike expectations by going long on 2-year Treasury note

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Hedge funds and other speculators have turned positive on the 2-year Treasury note for the first time in more than a year as investors cool their bets the Federal Reserve will be more aggressive than expected on rate increases.

Speculative net longs, the number of bullish bets minus the bearish ones, on futures for the 2-year note












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climbed to 67,767 contracts as of May 29, the largest bullish bet since Nov. 2016, according to Commodity Futures Trading Commission data.

For more than a year, hedge funds had aggressively shorted 2-year note futures on bets that the Federal Reserve would keep raising rates. The short-dated note is more sensitive to ideas about rates as other factors, including inflation expectations, have more sway over longer-dated paper.

Bond prices move in the opposite direction of yields.

“Fed rate hike expectations have been receding, at the margin,” said Dave Rosenberg, chief economist for Gluskin Sheff.

The Fed remains widely expected to deliver its second rate increase of 2018 when policy makers meet later this month. Beyond June, Fed funds futures last week showed that political turmoil in the Italian peninsula and panic in emerging markets had fewer investors looking for the Federal Reserve to deliver a total of four rate increases this year, with some even curtailing expectations for a third rise. Also, minutes from the Fed’s May policy meeting also indicated the central bank was willing to allow inflation to overshoot its 2% target, a sign that the bar for that fourth rate hike was higher than previously anticipated.

“The attention on this more dovish narrative following the sizable repricing of the policy path this year appears to be revealing cracks in the seemingly unwavering spec short position in the front-end,” said Jonathan Cohn, a rates strategist for Credit Suisse, in a note last week.

Shifting expectations for Fed policy helped push down the 2-year note yield by 16.1 basis points to a low of 2.32% on May 29, marking its largest one-day slump since March 2009, according to the WSJ Market Data Group.

The sudden plunge in the maturity’s yield last Tuesday, however, only pared some of its climb since last September, when it rose than 100 basis points, or 1 percentage point, as Wall Street fell in line with the Fed’s stance that a “transitory” shortfall in inflation last year would not derail the gradual but unstinting rate hike schedule.

See: BlackRock sees restored appeal in bonds most vulnerable to aggressive Fed

Read: Stock-market investors have fewer excuses for shunning bonds

Will speculators newfound bullishness last? Recent speeches by Fed governors Randal Quarles and Lael Brainard dampened expectations for a dovish undertone from the Fed by underscoring the strength of the U.S. economy. They argued though the central bank would monitor geopolitical jitters abroad, unless such concerns influenced domestic growth, they would not figure in monetary policy discussions.

Traders in the fed fund futures markets have partially rebuilt expectations for four or more rate increases, putting the probability at 37% versus a low of 14% on May 29, CME Group data shows. Since last Tuesday, the 2-year note yield has recovered more than half of its fall but has been unable to top its decadelong high of 2.61%.

Also check out: Cleveland Fed’s Mester says the Italian turmoil and a flattening yield curve haven’t changed her interest-rate view



Source : MTV