Piling into "Shorting US Treasuries": A "Short Squeeze" Only Needs One "Bad Data Point"

Original Author: Bao Yilong

Original Source: Wallstreetcn

Short positions in U.S. Treasury futures continue to pile up, and analysts believe that once economic data weakens or Fed officials signal a dovish stance, the market could face a sharp short squeeze.

Wallstreetcn noted that, dragged down by a surge in corporate bond supply, U.S. Treasuries extended their months-long slump on Tuesday, with the 30-year Treasury yield rising to its highest level since 2002. Meanwhile, elevated energy prices continued to fuel inflation pressure, further reinforcing bearish sentiment in the market.

However, at present, short positions in Treasury futures have become highly concentrated, and any unexpected signal of economic cooling could trigger a sharp unwinding of short positions, causing a rapid decline in yields in the short term.

This week, bond traders will focus on two key data points: the Fed's preferred inflation gauge to be released on Wednesday, and the monthly employment report at the end of the week. According to economists surveyed by Bloomberg, nonfarm payrolls for September are expected to rise by about 90,000, a sharp slowdown from the unexpected 162,000 in August.

Short Positions Accumulate Rapidly, Position Size Hits a New Near-Term High

According to CME data, over the past roughly two weeks, open interest in both 5-year and 10-year Treasury futures has climbed sharply.

According to U.S. Commodity Futures Trading Commission (CFTC) data, in the week ended September 22, asset managers added more than 100,000 short positions in 10-year Treasury futures, one of the largest weekly increases since 2023.

In addition, the 5-year contract saw position increases on 11 of the past 12 trading days, while the 10-year contract continued to expand on 13 of the past 14 trading days.

In terms of scale, since the start of last week, the combined new futures risk exposure in the two maturities has been about $32 million per basis point, equivalent to the current notional size of $75 billion in 5-year cash bonds.

Bank of America strategists including Meghan Swiber noted in a research report:

Futures positioning still leans toward further yield upside, and short positions in the short- and intermediate-term maturities are currently still profitable.

The team also noted that asset managers continue to increase Treasury shorts, especially concentrated in intermediate- and long-term maturities, while trend signals from commodity trading advisors (CTAs) also show they are "firmly maintaining Treasury shorts."

It is worth noting that behind the current increase in new positions, in addition to directional shorting, there may also be basis trades against cash Treasuries, or asset managers' hedging operations for bond holdings, which to some extent adds to the complexity of the market structure.

Short Squeeze Risk Rises, Options Market Already Shows Signs of Hedging

As shorting forces continue to accumulate, once economic data comes in below expectations or Fed officials make dovish remarks, the market could face a sharp short squeeze, at which point yields may plunge rapidly, at least in the short term.

Developments in the options market have already confirmed this concern. According to Bloomberg data, over the past week, the options skew for long-bond futures contracts shifted sharply, with the premium on put options rising to its highest level since August, indicating that traders are actively seeking protection against further yield increases, pushing up the cost of puts relative to calls.

In addition, some bearish hedge positions will expire at the end of this week, meaning these positions also cover the event risk of Friday's nonfarm payrolls data.

Meanwhile, JPMorgan's Treasury client survey showed that, in the week ended September 28, investor positioning remained broadly unchanged overall, with long positions still at their highest level since last November, indicating that some bullish forces remain and providing a certain foundation for a potential short squeeze.