Net short futures positions in US Treasury securities bear watching. On an aggregate level, shorts have been building up over the course of 2022 as inflation stayed persistently high, the Fed proved to be much more hawkish than it has been over the past few decades and the US economy stayed resilient. We are wary of short covering in the near term. Judging from the experience of the missed CPI print for October, the rates space appears to be more vulnerable to weaker US data (lower inflation or lower economic activity). This can probably be explained by the build-up of shorts that are now comparable to levels seen in late 2018, just before a large rally in USTs occurred as markets pre-empted a Fed pivot into cuts in 2019. In particular, the 2Y tenor looks especially vulnerable. It might not quite be Deja-vu in the current hike cycle and much will depend on incoming data and the Fed’s guidance at December’s FOMC meeting. However, considering that the Fed minutes did not show many members having conviction of a higher terminal rate and the fact that initial jobless claims finally missed (labour market might finally be softening) point to susceptibility of USD rates to any misses in NFP and / or CPI. If both of these soften materially, the market might start to price out hikes in 1Q. Due to stretched positioning, when the short covering materializes, it will almost certainly cause an overshoot of USD rates / yields to the downside (beyond what fundamentals would suggest). Scaling into receive 2Y USD rates might make sense.
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