Source: Zhitong Finance and Economics

Hedge funds are betting at the start of 2023 that US interest rates are about to peak, the Fed will remain high for a longer period of time, and the dollar will weaken slightly.

Judging from the economic data in the first week of this year, the volatility of financial markets and the speeches of US policymakers, this seems to be a reasonable macro strategy and a consensus that can be adopted.

The three-month guaranteed overnight financing rate (SOFR) futures short position held by speculators at the end of 2022 is one of the smallest this year, with a small short position in the dollar and a large short position on the Treasury curve, according to data from the Commodity Futures Trading Commission (CFTC).

Short positions are essentially bets that asset prices will fall, while long positions are bets that asset prices will rise. In terms of bonds and interest rates, yields and implied interest rates fall when prices rise and rise when prices fall.

In the week ended January 3, CFTC speculators increased their net short positions in three-month SOFR interest rate futures to 175218, but it was still one of the smallest net short positions in a volatile year.

Fund expectations for US interest rates peaked in August and September last year, when their net short positions exceeded 1 million contracts.

The rapid reversal since then suggests that the fund is much more neutral about the outlook for interest rates and inflation this year, believing that the Fed is about to end its rate hike cycle or that they have profited from a lucrative deal. Or both.

"in the final analysis, the Fed and the market generally believe that inflation will fall by 2023," said Torsten Slok, a partner at Apollo Global Management in New York. "

Be bearish on US debt

In 2022, hedge fund returns will be at their lowest level in 14 years, but macro strategies will perform much better. The macro index of industry data provider HFR rose 8.15 per cent in the first 11 months of this year, while the exchange rate index rose 12.58 per cent.

HFR is expected to release its full-year returns for December and 2022 this week, while industry peer Preqin is expected to release data later this month.

The small bets made by CFTC speculators on US short-term interest rates are in stark contrast to their large bets on two-and 10-year Treasuries, although the end of the Fed rate hike cycle and the economic slowdown are possible.

As of 2022, hedge funds had the third-largest net short position in 10-year Treasuries this year, with 383602 contracts. Funds have been shorting these futures since October 2021, and the selling tendency has intensified recently-weeks of bigger bearish bets followed soon after the correction.

The yield on the 10-year note has been falling since it hit a 15-year high of 4.30 per cent in October; it closed at 3.57 per cent on Friday. During this period, the reversal of the yield curve has also deepened, meaning that the yield on the 10-year note is further lower than that on the 2-year note.

But the fund still retains a large net short position. If this year is a year of buying bonds because of their low prices (either directly or relative to equities), the fund could be forced to make a U-turn.

The fund cut its net short exposure to two-year Treasury futures in the week ended January 3, but only slightly to 521508 contracts, still one of the largest in history.

Funds have been shorting two-year futures throughout the year, and any idea of taking positions for the Fed to shift to the Fed was dashed in October, when they increased their short bets to record levels.

On the foreign exchange front, the fund reduced its net short position in the dollar by about 1/3, betting $6.8 billion that the dollar would weaken against G10 currencies.

This is driven by large long positions in the euro. Funds bet $17 billion on the appreciation of the euro against the dollar, close to a two-year high, surpassing the $4.5 billion and $1.5 billion bulls betting on the appreciation of the yen and sterling, respectively.

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