Leveraged bets in US Treasury market could ‘amplify’ stress, BoE warns

4:33 pm Wednesday, July 12th, 2023

By David Randall

NEW YORK (Reuters) -Large leveraged bets by hedge funds in the U.S. Treasury market could “amplify stress” in global financial markets should rates markets move sharply, the Bank of England said in a report published on Wednesday.

Hedge funds have taken record short positions in two- and five-year Treasury futures this year, suggesting that fund managers expect short-term interest rates to continue to move higher. The yield on the 2-year Treasury note fell 10 basis points on Wednesday after touching 5.12% last week, the highest since June 2007.

Bond yields move in the opposite direction of prices.

Hedge funds, meanwhile, disputed the notion that they are undermining the security of financial markets.

“Our members understand the importance of strong capital markets and will continue to work with policymakers to enhance the resilience of the financial system,” the Managed Funds Association, a trade association representing hedge funds and the global alternative asset management industry, said in a statement.

The release on Wednesday of U.S. data showing consumer prices on a year-on-year basis rose by their smallest amount in more than two years in June could convince market participants that inflation is ebbing and prompt a reduction in the record short positioning, said Benjamin Jeffery, vice president of rates strategy at BMO Capital Markets.

“Really what the market is looking for is a little bit more clarity from the Fed and other global central banks as to where terminal rates will ultimately be, and that will ultimately translate into more conviction in the rates market,” he said.

Overall, mutual funds and other institutional investors have been adding to their long positions in Treasuries this year, while hedge funds have been increasing their bets that they will fall, Bank of America strategists wrote in a July 3 note.

“Asset managers continued to add to (Treasury) exposure with leveraged funds taking the other side,” the report noted.

(Reporting by David Randall in New YorkEditing by Paul Simao and Matthew Lewis)