As shown in the chart below, traders amassed the largest cumulative short position in 10-year Treasury contracts in history in late February 2017. To establish the short positions, traders borrowed Treasuries and sold them in the open market—essentially speculating that yields would rise and prices would fall, at which time they could profitably repurchase the securities.
We track this statistic because it can be an informative indicator of technical pressures in the market. Though counterintuitive, we have argued over the past few months that the record number of bearish bets on the 10-year Treasury would likely exacerbate any decline in Treasury yields. The reason being that if yields fell (and prices rose), short positions would lose value and traders may then be forced to buy Treasuries to cover their short positions, thereby increasing demand for Treasuries and driving yields down further. This can lead to a feedback loop, where yields fall further, triggering more short covering, which pushes yields down further still, and so on.
Our belief in this possibility seems to have been proven true over the last few weeks, as the 10-year Treasury yield has fallen from a peak of 2.63% on March 13 to 2.22% a month later on April 13, 2017; and with that, short positions in intermediate to long-term Treasuries futures markets have normalized from historically high levels, though the level of shorts remains high in shorter-term maturities. Other factors surely played into the move in the 10-year Treasury: a general shift in investors’ portfolio allocations toward more conservative investments amid equity market volatility and geopolitical risks, for example. However, technical pressure due to positioning in the futures market was undoubtedly an exacerbating factor. While catalysts such as weaker economic data or geopolitical events always have the potential to push yields lower still, the normalization of short position levels on intermediate- and longer-term Treasuries may remove at least one factor that could lead to additional volatility.