Investors Bet Against Treasurys as Bond Market Anxiety Intensifies
By Daniel Kruger and Gunjan Banerji
Bond investors remain on edge after last month's big price swings across financial markets, with bearish bets on U.S. Treasury futures prices reaching a new high in February.
The latest jitters were triggered this week by Federal Reserve Chairman Jerome Powell's congressional testimony about the prospects for rising growth and inflation, which sparked a new bout of selling that sent yields back near multiyear highs and nearly reversing three days of gains.
Signs of worry have proliferated recently. Futures markets show investors recently held the most-bearish positioning on record in data going back to 2003. Bidding at February's Treasury auctions declined as the supply of bonds rose. During the week ended Feb. 14, investors pulled the largest amount from fixed-income mutual funds and exchange-traded funds since just after the U.S. presidential election. And Treasury market volatility, as measured by Bank of America Merrill Lynch's MOVE index, recently hit its highest level since April.
Such extremes of positioning and volatility add to pressures that drove investors to sell bonds in the first two months of the year, with the yield on the benchmark 10-year U.S. Treasury note trading near 2.9% Wednesday. Such pressures include the prospect of future interest rate increases, concerns about accelerating inflation -- which chips away at the purchasing power of bonds' fixed payments -- and a widening federal budget deficit pushing the Treasury Department to boost debt sales, increasing the supply of bonds.
The selling is worrying to some investors. Though rising rates can signal increasing economic health, this year's half-percentage point climb in the yield on the benchmark 10-year U.S. Treasury note was a major factor behind the recent stock market tumble, forcing investors to reconsider valuations based on lower yields. The 10-year yield, which rises as bond prices fall, is a key barometer for financial markets, influencing borrowing costs for individuals, corporations and state and local governments, along with calculations used to evaluate stock prices.
Mr. Powell did little to alleviate those concerns in congressional testimony this week. The new Fed chairman's comments that inflation pressures are strong and that fiscal policy is playing a supporting role in economic growth helped snap three days of gains for the 10-year note. Economic growth can lure investors into riskier assets and push the Fed to raise interest rates, hurting the value of outstanding debt.
Those nerves are evident in recent data on Treasury futures, which showed investors recently accumulated the biggest wager that yields on 10-year Treasurys will rise since 2003, when the government began tracking the data, according to a JPMorgan Chase report parsing data across different Treasury maturities from the Commodity Futures Trading Commission. Investors can use Treasury futures to make directional bets or hedge other parts of their portfolios.
It is the latest indication that some investors expect sustained declines in bond prices, after the worst start to the year for Treasurys since 2009, some analysts said.
The market has "come around to the view that rates are going to be higher," said Mark Cabana, a rates strategist at Bank of America Merrill Lynch.
One-sided positioning in futures markets can exacerbate market moves, some analysts said, potentially setting up large swings in bond prices in coming months, after 2017 was the calmest year in almost four decades.
Fears of rapidly rising yields and concerns about a pickup in inflation have fed these positions, some analysts said.
Some economists now expect as many as four interest-rate increases from the Fed, more than the three signaled by the central bank. Analysts also said the additional borrowing resulting from recent tax cuts could push yields higher.
Some warn that if yields continue to quickly rise, the bond market could spark a new pullback in stocks. If the 10-year yield darts to 4.5% by the end of the year, stock prices could take a severe hit, wrote Goldman Sachs analysts in a Feb. 24 note.
Wagers that the 10-year Treasury yield is about to break above 3% for the first time in four years face obstacles, however. Many investors have said that as yields approach that level, the debt becomes more attractive to both individual and institutional investors. Others point to the decline in oil prices in February as a sign inflation data could weaken.
Sean Simko, head of fixed-income portfolio management at SEI Investments, said he thinks yields will continue to rise over the medium term as the Fed raises rates and issuance increases, but with yields climbing "too far, too fast," bonds have become attractive in the near term. He said he bought 10-year Treasurys when the yield crossed above 2.9%.
"Everybody seems to be getting on the bandwagon" betting on the Fed becoming more aggressive in response to recent inflation data, said Larry Milstein, head of government and agency trading at R.W. Pressprich & Co. What often happens, however, is that when traders all make the same bet at the same time, "the market tends to go the other way. It's more of a bullish signal than a bearish signal, frankly."
Corrections & Amplifications
This article was corrected at 3:18 p.m. ET because an earlier version incorrectly said bearish bets on Treasury futures prices reached a high this month in the first paragraph. Bearish bets on Treasury futures hit a high in February.