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Have Hedge Fund Treasury Purchases Stalled?
Tracking down hedge fund Treasury holdings is difficult. What’s clear is that they’re shadowing, not shaping, the market.
Some data indicate that hedge funds were heavy buyers of Treasuries in 2015 and in January and February of this year, before dumping some of their holdings over the past few weeks.
Hedge funds are largely market-trend followers, analysts say. Treasury yields bucked many investors expectations in the second half of 2015, sliding much of that time, despite expectations that the Federal Reserve would hike interest rates. So hedge funds joined in the Treasury-buying trend.
Then Treasury yields plunged in January and February amid lessened expectations for Fed rate hikes this year, slow global economic growth and falling commodity prices. Again, hedge funds piggybacked on the Treasuries rally.
Many hedge funds are pure momentum players, says David Schnautz, an interest-rate strategist at Commerzbank in London. They wait until something moves, and then they jump on the bandwagon. These funds arent wedded to an economic outlook; they just care about making money.
But now the trend has stalled, with Treasury yields bouncing up and down over the past seven weeks. It already smells a bit like the big hedge fund wave is over, at least for the time being, Schnautz says. They need to be in something where theres action. Its hard to imagine they find this market sexy now. A grinding market, with yields moving sideways, isnt as interesting for funds as are volatile markets.
There are no official numbers for hedge fund purchases of Treasuries. Some analysts use as a proxy the Feds data for holdings of Treasuries by households and nonprofit organizations. That latter designation includes domestic hedge funds, private equity funds and personal trusts. Treasury holdings for this category soared 46 percent last year to a record $1.27 trillion, according to the latest Fed report.
But not everyone puts much stock in those figures. Alex Li, chief U.S. Treasury and inflation strategist for Deutsche Bank in New York, says the Treasury Departments data on holdings of Treasuries by Caribbean banking centers are more accurate, since many hedge funds are based there. Those holdings rose a more modest 29 percent, to $351.7 billion, in 2015. For this year, that total climbed to $361.1 billion as of February 29.
Meanwhile, the Commodity Futures Trading Commission publishes weekly data about holdings of Treasury futures by leveraged funds, which include hedge funds, money managers and registered commodity pool operators.
Those numbers show that leveraged funds were short Treasury futures to the tune of $134.8 billion ten-year-contract equivalents as of December 29, according to Bloomberg. The short positions started shrinking in January and by March 22 had dipped to $103.4 billion. As of April 12, the shorts had increased again, to $163.8 billion.
Its difficult to know what to make of these data. Hedge funds may be bearish on Treasuries, or they may be bullish and are selling futures as a hedge against long Treasury positions in the cash market. Or they may simply be executing a basis trade, trying to take advantage of the fact that futures are expensive relative to Treasuries in the cash market, Li says.
Jue Xiong, a research analyst at Bank of America, notes that leveraged funds have been selling two-year and ten-year Treasury futures in recent weeks. That could mean theyre positioning themselves for the next rate hike, possibly this quarter, she says.
But leveraged funds are long 30-year Treasury futures in the amount of $2.6 billion. That indicates hedge funds arent convinced the yield curve will steepen in the long term, Xiong says. There are several possible explanations for that view: It could be that the funds dont expect economic growth and inflation to accelerate much, or they could think that 30-year bonds represent good value now, she says.
Sassan Ghahramani, CEO of New Yorkbased SGH Macro Advisors, which advises hedge funds and other money managers on economic policy, sees evidence that hedge funds are still buying Treasuries. They have gotten hurt trying to short the market, he says. Its an understandably Pavlovian response: You generally lose money if you sell, and make money if you buy.
And what are hedge funds likely to do in the Treasury market going forward? Commerzbanks Schnautz sees ten-year Treasury yields gradually rising to 2 percent by the end of the quarter and 2.25 percent by the end of the year (from 1.77 percent on April 20). As such a move is widely expected, it probably wouldnt interest hedge funds enough to make them act, he says. But a sharp move down in yields could excite them.
Hedge funds can cause an increase in market volatility when they go in or out of the Treasury market en masse, especially with banks curbing their bond trading, analysts say. But the funds dont have much influence on market direction. Hedge funds are shadowing what the real money is doing, Ghahramani says, referring to the worlds largest asset managers. The major positions come from them.
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