Image may be NSFW.
Clik here to view.
- Hedge funds and other large speculators are currently holding their largest-ever short position on one of the market's most closely watched assets.
- History suggests that positioning to this degree will be detrimental to their long-term prospects, since it's acted like a contrarian indicator in the past.
In the world of investing, it's usually a troublesome development when a position gets too popular.
Pundits prefer to use the word "crowded" to describe these trades, which can quickly escalate into painful situations on the first sign of stress as investors simultaneously stampede towards the exits.
Such a situation is brewing in the fixed-income market right now, with hedge funds and other large speculators the most bearish on record on both 5- and 10-year Treasurys.
Image may be NSFW.
Clik here to view.
This is significant because of what it signals about the possible direction for Treasury yields, which investors have been closely watching for hints around the Federal Reserve's pace of rate hikes. Since yields rise as underlying bonds decline, this historic short bet is actually a massive wager on higher yields.
That's a troublesome development for equity traders in particular because of how sensitive the stock market has been to recent movements in the Treasury market. You may recall the S&P 500 dropped as much as 2% on April 24, the day yields climbed above the 3% threshold for the first time since 2014.
But if history is any indication, the situation may end up being worse for the hedge funders so committed to their bond trade. Back in early 2017, the last time Treasury shorts hit a record, the benchmark wound up plummeting almost 50 basis points. That caused yields to spike, forcing hedge funds to cover their positions, most likely at deep losses.
What Treasurys will do next is anyone's guess, but you can be rest assured hedge funds and their investing brethren will be keeping a close eye on it. After all, they're a notoriously fickle bunch, as you can see from their wildly fluctuating positions in the chart above.
If anything transpires that shakes their confidence in the short-Treasury trade, they'll likely be quick to throw in the towel, considering no one wants to be the last one out the door.
In the end, how the situation shakes out will ultimately be dictated by the Fed and how it proceeds with monetary tightening.
Inflation is arguably the biggest input to the central bank's rate decision, so that's probably a good place to start if you want to monitor at home.
