Extreme Treasury Positioning Shows Short Squeeze Has Room to Run

Edward Bolingbroke, Bloomberg News

The US Treasury building in Washington, D.C., US, on Sunday, May 22, 2022. The Federal Reserve raised interest rates by 50 basis points earlier this month and the chairman indicated it was on track to make similar-sized moves at its meetings in June and July. Photographer: Joshua Roberts/Bloomberg , Bloomberg

(Bloomberg) -- Hedge funds increased already elevated net short positions on US Treasuries last week, fueling a rout that sent 10-year yields to 4% for the first time in more than a decade.

The shift fueled short squeeze price action, with Treasuries already under pressure amid thinning liquidity and fears of more aggressive Federal Reserve rate increases. The 10-year yield surged to the highest since 2008 last week, before tumbling back after the Bank of England resumed buying long-dated bonds.

The latest JPMorgan Treasury client survey showed a small reduction in short positions in cash, while in options the call/put skew in 10-year futures has shifted closer to neutral, indicating potential hedging of short positions via demand for call structures.

The following is a rundown of how positioning unfolded in various markets through Monday.

Getting Short

Hedge funds were net sellers of duration by around 319,000 10-year note futures equivalents in the week through Sept. 27, which appeared to lead the cash 10-year yield rise to test the 4% level. After aggressive short covering in the previous week, hedge funds were back adding to short positions across most tenors in Treasury futures. On the flip-side, asset managers added around 210,000 10-year futures equivalent to net long position across most maturities.

Hedge funds mostly added to net short positions in both 10-year note contracts ($11.2 million per basis point risk) and ultra-long bond futures ($8.2 million per basis point risk). Asset managers were most active in 10-year notes and ultra-long bond futures also, where net longs were added to over the week.

Front-end Chop-Out

US futures risk was added over past week in all contracts except two-year note futures, where the 78,271 futures drop equates to approximately $3 million per basis point risk. Largest amount of risk was added to 10-year note futures as yields ranged from 3.68% to 4.015% over the week.

Strong Blocking

Block trades were active over the week, with most activity seen in 10-year note futures where around $4.4 million per basis point printed. Highlight of the week was a 25,000 10-year futures block on Sept. 26 which printed at a level of 111-15, consistent with a buyer with 10-year yields around 3.87%.

Bearish Skew Vanishing

Into the recent rebound in Treasuries, the premium paid to cover a continued rise in yields has been reduced as call/put skew moves closer to neutral from the previous week, when it favored a premium for put options. This may indicate covering of duration shorts via the options market and demand for calls over puts.

Outstanding open interest in December 10-year Treasury options shows a cluster of puts forming around the 108.00 to 111.00 strikes, equivalent to around 4% to 4.40% in 10-year yields. Meanwhile, most elevated open interest is at the 116.00 strike (47k calls and 29k puts) which is equal to approximately 3.25% 10-year yield.