Hedge funds have begun making bets for the year 2023 on the following scenarios: U.S. interest rates are about to peak; the Federal Reserve will maintain higher rates for longer; and the dollar will fall significantly.
Considering the economic data, financial sector movements and language from U.S. policymakers during the first week of 2023, this would appear to be a fair – and relatively consensus – macro strategy to deploy.
At least for now.
Speculators ended 2022 with one of the lightest three-month SOFR rate futures short holdings of the year, a modest short dollar position, and significant short positions throughout the U.S. Treasury curve, according to data from the Commodity Futures Trading Commission (CFTC).
A short position is fundamentally a bet that the price of an asset will decrease, whereas a long position is a wager that the price will increase. Bond yields and indicated rates decrease when prices increase and increase when prices decrease.
CFTC speculators upped their net short position in three-month-long Secured Overnight Financing Rate (SOFR) futures to a grand figure of 175,218 contracts during the week through January 3, but it remains one of the smaller net short positions of a difficult year.
In 2022, hedge funds are expected to deliver their poorest returns in 14 years, but macro techniques have done significantly better. Industry data provider and support HFR’s macro index rose 8.15% in the initial 11 months of the fiscal year, and the currency index gained 12.58%.
HFR is set to reveal its December and comprehensive-year 2022 returns data this week, and industry competitor Preqin will follow later this month.
Even though the Fed’s cycle of rate hikes is drawing to an end and the economy is slowing down, CFTC speculators are still holding substantial bets on two- and 10-year Treasuries. This is in contrast to the minor bets they are making on short-term U.S. rates.
With 383,602 contracts, funds had the third-largest net short position of the year in the 10-year market at the end of 2022.
Since October 2021, funds have been shorting the futures, and recently the sale bias has become more pronounced; pullbacks have been swiftly backed by weeks of even bigger bearish bets.
The 10-year yield has decreased since reaching a 15-year peak of 4.30% in October; on Friday, it closed at 3.57%.
Additionally, at that time, the yield on the 10-year note continued to decline below the yield on the two-year note.
However, funds have kept a sizable net short position.
Funds might be obliged to make a U-turn if this is the year to purchase bonds because they are inexpensive both directly and compared to equities.
In the week ending January 3, funds reduced their net bearish exposure to two-year Treasury futures, but only somewhat, to 521,508 contracts, making it one of the largest ever.
All year long, funds have been shorting two-year futures, and in October, they increased their negative wagers to record highs, putting an end to any hopes of planning for a Fed pivot.
Funds cut their net dollar short position in the foreign exchange market by about a third, and they ended the year with a $6.8 billion wager that the dollar would decline in value versus the G10 currencies.
The substantial long euro position is what is responsible for that.
The $17 billion bet by funds on the euro strengthening against the dollar dwarfs the $4.5 billion as well as $1.5 billion long-dollar wagers against the yen and pound, respectively.
This wager is nearly the largest in two years.
