Hedge funds slashed US rate hike bets ahead of Fed: McGeever

ORLANDO, Fla., Dec 19 (Reuters) – Hedge funds slashed their wager on rising US interest rates and deepened their bearish bets against the dollar ahead of the Federal Reserve’s last policy meeting, an indication of how they may be looking to position themselves for the year ahead.

Commodity Futures Trading Commission data show that speculators now hold the smallest net short position in three-month ‘SOFR’ rate futures since April, and the largest net short dollar position since July last year.

The CFTC data is for the week ending Dec. 13, just before the Fed raised rates by 50 basis points and Fed Chair Jerome Powell gave his clearest pledge yet that more tightening is coming and rates will stay higher for longer.

In the very short term, funds will have been caught out by the Fed’s surprisingly hawkish stance. But zoom out, and two broader pictures emerge: they are taking profit on two highly lucrative trades this year, and are setting out their stall for 2023.

The CFTC report showed that funds and speculators cut their net short position in three-month Secured Overnight Financing Rate futures to 332,000 contracts from 532,000 the week before.

That is the smallest since the week ending April 3, and the week-on-week change is third biggest since these contracts were launched in 2018.

LEVELING OUT

At the start of the year, funds’ net short position was only 43,000 contracts, while SOFR contracts implied a fed funds rate of just 0.85% by the end of this year and 1.4% next year.

That short position hit a record 1.06 million contracts in early September and funds have been scaling back ever since, a trend that has broadly coincided with the leveling out of ‘terminal rate’ expectations.

Since mid-October, the SOFR curve has consistently implied a peak fed funds rate of around 5.00% by June next year. Significantly, SOFR pricing also implies around 50 bps of rate cuts in the second half of 2023.

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.

Hedge funds take positions in short-dated US rates and bonds futures for hedging purposes, so the CFTC data is not reflective of purely directional bets. But it is a pretty good guide.

USD 3 BILLION DOLLAR SHORT

In currencies, the CFTC report showed that funds grew their net short dollar position against other G10 currencies to the largest since July last year – a USD 3 billion bet that the dollar will weaken.

Again, funds are cashing in on a winning trade and positioning for the year ahead.

In January CFTC funds were super bullish on the dollar, with a net long position worth around USD 20 billion, and the dollar soared 20% through September. Funds then began whittling that away, and since then the dollar has declined almost 10%.

Even though the Fed is still promising to tighten policy more, there are other central banks further behind in the cycle and are likely to do more than the Fed in 2023. Step forward Christine Lagarde and the European Central Bank.

CFTC funds are now holding a USD 16.6 billion net long euro position, compared with a USD 6 billion net short position at the start of September.

(By Jamie McGeever; Editing by Andrea Ricci)