Column: Hedge Funds Go Long Dollars, Curve Steepers Before Fed Liftoff

Traders work on the floor of the New York Stock Exchange (NYSE) in New York, U.S., March 17, 2022. REUTERS/Brendan McDermid

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ORLANDO, Fla., March 21 (Reuters) – Hedge funds rushed to raise interest rates from the Fed betting on a stronger dollar and a steeper U.S. yield curve, but have so far been taken badly as the dollar has since fallen slightly and the curve has flattened considerably.

Futures market data for the week to March 15, the day before the first U.S. interest rate hike since 2018, showed speculators increased their net dollar long position by the biggest amount this year.

The data also revealed the biggest shift in favor of two-year Treasury bill futures in more than a year, a reduction in the net short position twice as aggressive as the reduction in the net short position of 10-year bond funds.

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All in all, it was effectively a bet that the two-year yield would fall faster than the 10-year yield, thus “steepening” the curve. The opposite happened.

The spread between two- and ten-year Treasury yields narrowed from around 13 basis points to just 18 basis points after the Fed’s rate hike. The inversion of this part of the yield curve, which has preceded every recession for the past 45 years, is near.

The funds had successfully bet on a flattening of the yield curve in the first two months of the year. But in recent weeks they have tried to position themselves for a reversal that has yet to materialize.

The latest Commodity Futures Trading Commission showed the funds reduced their net short position in two-year Treasury bills by 92,313 contracts, the biggest weekly move since February last year. They reduced their net short position in 10-year Treasury bills by 56,723 contracts.


A short position is essentially a bet that the price of an asset will fall, and a long position is a bet that it will rise. In the case of bonds, yields rise when prices fall and fall when prices rise.

The Federal Reserve’s quarter-percentage-point rate hike on March 16 was expected, but policymakers’ hard-hitting forecasts of how quickly rates will need to rise to rein in inflation were not. Read more

“The March FOMC meeting surprised with its hawkish tilt and now reflects a Fed that has caught the curve, acknowledging the seriousness of the inflation/employment mismatch,” Bank of America’s U.S. strategists wrote on Friday.

This supports a higher terminal rate and overall level of interest rates, as well as a flatter curve, they added.


The CFTC data also shows that the funds have made a big bet on the strengthening dollar. They increased their bullish bets on the dollar against a wide range of currencies by almost $4 billion, the biggest weekly increase since November.

But the dollar struggled after the Fed. It fell 0.5% against a basket of currencies and nearly 1% against the euro, partly because traders now believe the dollar price is the most aggressive on the rate outlook. Americans.

Further analysis of the latest CFTC report shows that the rise in net dollar long positions was driven by a historic wave of euro selling.

Net long positions in the euro have been reduced by more than 40,000 contracts, the largest weekly swing against the single currency since 2018 and the fourth largest on record.

To dig even deeper, this was entirely due to funds liquidating long positions rather than opening new short positions. Longs were reduced by 40,643 contracts, the second since the launch of CFTC contracts in 1999.


Even though the European Central Bank is speaking sternly on inflation and traders are anticipating rate hikes later this year, the Russian-Ukrainian war has clouded the euro zone’s economic outlook and sentiment towards the euro.

But could the dollar be about to rebound? MUFG analysts note that the dollar tends to rise when the yield curve flattens from 50 basis points to zero, as it did from March 1997 to January 2000, from April 2005 to December 2005 and from April 2018 to August 2019.

“The dollar story is pretty good at this point for the 2s/10s curve gap. We wouldn’t expect the same magnitude of gains…but dollar strength looks likely,” they wrote on Friday.

(Views expressed here are those of the author, columnist for Reuters.)

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By Jamie McGeever; edited by Diane Craft

Our standards: The Thomson Reuters Trust Principles.

The opinions expressed are those of the author. They do not reflect the views of Reuters News, which is committed to integrity, independence and freedom from bias by principles of trust.

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