Bond Market Perspectives: Tide Turning in 10-Year Treasury Futures

Speculators who built the biggest net short position on record in 10-year Treasury futures have reversed course.

As shown in the LPL Chart of the Day, non-hedging traders’ net short position in 10-year futures decreased for five straight weeks through October 30, the longest such streak since April 2017. Short positions in these contracts project lower prices and higher yields, while long positions project higher prices and lower yields.

Speculators Cut Records Net Short Positioning in 10-Year Treasury Futures

We typically reference Treasury futures positioning as a sentiment indicator for certain asset classes, so the stark change in positioning shows us that investors are skeptical of the 10-year yield’s recent rally to 7-year highs. Non-hedging futures traders amassed what was the largest short position on record in 10-year Treasury futures on September 25 as rates were range-bound for several months.

“The tide is turning in Treasury futures, which shows us the futures market thinks the rate rally may be overdone,” said LPL Chief Investment Strategist John Lynch. “Pricing and wage pressures remain at manageable levels, and U.S. yields remain attractive to global investors.”

Since September 25, speculators have added about 103,500 long contracts and closed about 113,700 short contracts. During that same period, the 10-year yield has jumped from 3.10% to as high as 3.24% on November 8, and the accompanying selloff in Treasury prices has convinced traders that rates may be capped short term.

Rates have rallied swiftly recently as economic growth has gained traction and inflation measures have reached cycle highs amid gradual interest-rate hikes. Still, we agree with the futures market here, as we expect gains in U.S. government yields to be limited by relatively low inflation expectations. As the 10-year yield has climbed, the 10-year breakeven rate (the difference between the yields of nominal Treasuries and those of Treasury Inflation Protected Securities) has fallen to its lowest level of the year, indicating that the uptick in inflationary pressures is largely priced in. We also expect global demand to keep a lid on rates as fixed income investors favor U.S. Treasuries for diversification, valuation, and income.

IMPORTANT DISCLOSURES

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

The term Futures refers to future contracts, a financial contract obligating the buyer to purchase an asset (or the seller to sell an asset) at a predetermined future date and price. Contracts detail the quality and quantity of the underlying asset, and are standardized to facilitate trading on a futures exchange. Futures are used to either hedge or speculate on the price movement of an underlying asset, such as a physical commodity or financial instrument. U.S. Treasury Note and Bond Futures are listed for trading on and subject to the rules and regulations of the Board of Trade of the City of Chicago, Inc. (CBOT). CBOT lists futures on Treasury securities covering a broad set of maturities, including the benchmark 10-Year Treasury Note futures.

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