“Don’t fight the Fed” is a well-worn market maxim, and hedge funds are sticking to it like glue. U.S. futures markets positioning data show that speculators are heeding the increasingly clear signals from Federal Reserve officials that interest rates will be raised as high as is necessary to bring inflation back under control.
The Commodity Futures Trading Commission report for the week to August 23 – three days before Fed Chair Jerome Powell’s Jackson Hole speech – shows that funds increased their record bet on higher interest rates, and amassed their largest short position in two-year Treasuries futures in over a year.
In light of Powell’s relatively hawkish speech in Wyoming, which slammed Wall Street and pushed up the Fed’s ‘terminal rate’ market pricing implied by ‘SOFR’ interest rate futures, it is proving to be a winning strategy.
The latest CFTC report shows that speculators’ net short position in three-month SOFR futures stood at a record 1.052 million contracts in the week through Aug. 23.
That is up from 956,971 contracts the week before. The net short position has doubled in the space of a month.
Funds also increased their net short position in two-year Treasuries to 241,143 contracts, the biggest bearish bet on short-dated bonds since May last year.
A short position is essentially a wager that an asset’s price will fall, and a long position is a bet it will rise. In bonds and rates, yields fall when prices rise, and move up when prices fall.
JOB NOT DONE
After Powell’s speech on Friday, traders pushed the Fed’s terminal rate implied by Secured Overnight Financing Rate futures, to be reached by March next year, above 3.80%. Early this month, the terminal rate was around 3.20% and priced for December this year.
What’s even more striking than this rise of around 60 basis points is the jump in implied rates for the end of next year. The December 2023 SOFR contract on Friday implied a fed funds rate of 3.45%, 90 bps higher than the 2.55% implied on Aug. 1.
Traders’ are molding a pretty firm ‘higher for longer’ view of the Fed, and thoughts of a pivot next year are evaporating. Only 35 bps of easing is priced in for the back end of next year, down from 60 bps a few weeks ago.
Even though inflation appears to be cooling, Powell was clear that the Federal Market Open Committee is taking no chances.
“The bottom line was that the FOMC’s job is not done and that it will need to follow through with additional hikes — despite potential economic pain — … and then keep policy restrictive for a time,” economists at Barclays wrote on Friday.