Bets against global bonds by trend-following investors have surged to unprecedented levels, significantly raising the stakes for the upcoming US inflation data. Any data that triggers a bond rally could force the liquidation of massive short positions held by Commodity Trading Advisors (CTAs).
According to UBS data, CTAs, which aim to profit from price trends across various asset classes, tripled their underweight bond positions in late July compared to two weeks earlier, and have largely maintained those levels since. UBS strategist Nicolas Le Roux noted that ahead of the inflation data release, each one-basis-point move in the 10-year US Treasury yield represents a profit-and-loss exposure of approximately $300 million for CTAs, the highest level since UBS began tracking the data in 1990.
The US July Consumer Price Index (CPI) report, set for release on Wednesday evening Beijing time, will serve as the most immediate market catalyst. The data could either reinforce or weaken expectations for a Federal Reserve rate hike as early as September, forcing traders to readjust their positions. Interest rate swaps currently show the market pricing in a near 50-50 probability of a 25-basis-point Fed rate hike in September.
Dense short positions raise liquidation risk
In recent months, elevated oil prices, persistent expectations of central bank rate hikes, and expanded government borrowing have driven global government bond yields higher. The 30-year US Treasury yield hit its highest level since 2007 last month and has remained near those highs. The ongoing bond selloff has prompted CTAs to add to their short bets, with this group managing an estimated over $400 billion in assets.
However, the concentration of these positions has created significant reversal risk. Phoebe White, UBS's head of US interest rate strategy, stated, "There's not much room left to add to short positions, and the risk is clearly asymmetric." She pointed out that if bond prices rise, the likelihood of traders covering shorts is far greater than the willingness to add more shorts if bond prices continue to fall.
Strategists at Bank of America have also noted the extreme bearishness of CTA positions, describing the group as "heavily short," particularly in short-dated bonds.
CPI data could trigger a position overhaul
"If the data doesn't support a September rate hike, it could challenge the crowded short positions, especially given the large CTA shorts and underweighted active funds," wrote Bank of America strategists, including Meghan Swiber, in a report on Monday.
After last Friday's weaker-than-expected nonfarm payrolls data, Phoebe White and her colleagues recommended clients buy two-year US Treasuries. Their bullish rationale included two points: signs that inflation may have peaked and the current crowded short positions themselves, which could add extra upward momentum during a bond rebound.
Market positioning indicators show divergence
Multiple positioning indicators suggest investor sentiment is turning cautious. In the week ending August 10, JPMorgan's US Treasury client survey showed investors shifting from net long to neutral, with net long positions falling to their lowest level since May 18.
In the SOFR options market, new risk exposure last week was primarily concentrated around the 96.25 strike price, led by December contracts. Meanwhile, positions related to a put options combination sold on August 7 saw a sharp decline, indicating that some traders have begun actively reducing put exposure following the soft nonfarm payrolls data. Additionally, the cost of hedging Treasury futures has stabilized after a surge in put demand last week.