U.S. asset managers have loaded short positions in U.S. Treasury securities futures as they anticipate a recession – this could be triggered by a disrupted trading pattern in March 2020 and some unexpected events, such as a U.S. government shutdown. .
- Bank officials are now pointing to the same market concerns that drove U.S. Treasury yields higher at the start of the pandemic.
- Hedge fund speculators have amassed $600 billion in net short positions in Treasury futures, which could disrupt the bond market if they suddenly had to sell their holdings.
- The Bank for International Settlements (BIS) warned financial markets about the size of these investors’ bets on Treasurys.
- A break from such sales could quickly raise yields and cap prices on 10-year Treasurys, a proxy for mortgage rates and a sign of investors’ economic sentiment.
In the year In 2020, a global pandemic causes a financial market crash that shakes bond markets and raises US Treasury yields. Such dislocations occur when financial markets operate in stressful situations and stop selling off the value of assets. Could the US government budget shutdown in the coming weeks do the same?
The Bank for International Settlements (BIS) thinks so in a recent publication.
“Given these experiences, the current build-up of leveraged short-term positions is a financial vulnerability that should be monitored due to potential margin swings in US Treasury futures,” the BIS said in its quarterly review published this week.
On the margin
Traders and asset managers amassed $600 billion in net short positions in U.S. Treasury futures, the highest since late 2019, with most positions tied to arbitrage trading and U.S. Treasury securities. Most of them borrowed money on margin to start the business and have to post margin regularly to maintain it.
In this so-called financial basis trading, traders try to make money on the difference between futures and cash securities – in this case, usually 2-, 5- or 10-year Treasury securities. As long as traders don’t want to come up with too much margin, the trade will work.
But sometimes brokers who offer traders need more profit to execute the trade. That forces merchants to shell out more money or close their businesses, partly because they use Treasury securities to finance their borrowing.
In this case, closing the trade means selling US Treasury securities. And if many traders try to do it at the same time, chaos can occur.
2020 Dash in cash
In the year That’s what happened in March 2020 when the outbreak hit. At the same time, many traders tried to sell treasury securities to close positions, demand for those securities dried up, investors sold securities in what is now called a “cash dash” in preparation for the epidemic closing.
The 10-year U.S. Treasury yield more than doubled to 1.27 percent on March 18, 2020, from nine days earlier, as traders and investors tried to sell off the bulk of U.S. Treasury securities.
A similar increase occurred a few months ago when the 10-year yield rose from 1.46% to 1.90% in a nine-day period. In both periods, large increases in initial margin requirements preceded the rate of production, with the sudden arrival of the epidemic exacerbating the latter phenomenon.
According to Joseph Wong, chief investment officer at Monetary Macro and a long-time Treasury trader, the current heavy net short positions in the U.S. market could create a similar situation—especially if traders have to bring in more margin.
“If you’re in the business now and the margin goes up, you go out,” Wong said.
In this case, a widespread push to “get out” could send markets reeling and drive Treasury yields higher. But he added that the status quo is likely to last for some time in the absence of rising margin requirements or an unforeseen event.