US Treasury futures leverage, positions back on the rise: McGeever By Reuters

By Jamie McGeever

ORLANDO, Florida (Reuters) -Leverage in the U.S. Treasury market is picking up again, counterintuitively feeding off a “higher-for-longer” interest rate environment and building up potential trouble in the event of a price or rate shock.

After gradually but steadily scaling back exposure earlier this year, asset managers and leveraged funds are now rebuilding their respective long and short positions in Treasury futures contracts at a rapid clip.

There is a lot of anxiety swirling around the U.S. bond market just now – much of it justified – with inflation proving sticky, and the prospect of huge deficits for years to come calling into question the depth and strength of investor demand.

But the longer interest rates are kept on hold, the more attractive it is for futures market participants – asset managers are drawn in by higher yields, and higher yields make the ‘basis trade’ more appealing for leveraged funds on the short side.

Data shows that asset managers’ aggregate long position, spear-headed by mutual fund buying, has rocketed to a new record and leveraged funds’ short position is also expanding, bringing the basis trade back into focus.

The basis trade involves leveraged hedge funds arbitraging the small price difference between cash Treasuries and futures, a trade funded via the overnight repo market. Regulators have warned of major financial stability risks if these funds, some levered up to 70x, are forced to quickly cover their positions.

DISPROPORTIONATE

Commodity Futures Trading Commission data for the week to April 30 show that asset managers’ aggregate long position in two-, five- and 10-year Treasury futures rose to 8.15 million contracts, worth a record $1.045 trillion. That’s up 12% on last year’s high.

The shift at the short end has been even greater. Asset managers’ long position in two-year futures is now worth $458 billion – a new record, up 17% from last year’s peak, and remarkably, up more than a third in the last month.

These figures coincide with a new 82-page paper ‘Reaching for Duration and Leverage in the Treasury Market’ by Federal Reserve economists, a deep-dive analysis of positioning data in Treasuries futures.

The paper doesn’t cover developments in the last few weeks but does shed light on the broader trend, which shows the rise in asset manager longs in Treasury futures fueled by “disproportionately large…