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ORLANDO, Fla., Aug 29 (Reuters) – “Don’t fight the Fed” is a well-worn market maxim, and hedge funds are sticking to it like glue.

US futures markets positioning data show that speculators are heeding the increasingly clear signals from Federal Reserve officials that interest rates will be raised as high as is necessary to bring inflation back under control.

The Commodity Futures Trading Commission report for the week to August 23 – three days before Fed Chair Jerome Powell’s Jackson Hole speech – show that funds increased their record bet on higher interest rates, and amassed their largest short position in two-year Treasuries futures in over a year.

In light of Powell’s relatively hawkish speech in Wyoming, which slammed Wall Street and pushed up the Fed’s ‘terminal rate’ market pricing implied by ‘SOFR’ interest rate futures, it is proving to be a winning strategy.

The latest CFTC report shows that speculators’ net short position in three-month SOFR futures stood at a record 1.052 million contracts in the week through Aug. 23.

That is up from 956,971 contracts the week before. The net short position has doubled in the space of a month.

Funds also increased their net short position in two-year Treasuries to 241,143 contracts, the biggest bearish bet on short-dated bonds since May last year.

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.

JOB NOT DONE

After Powell’s speech on Friday, traders pushed the Fed’s terminal rate implied by Secured Overnight Financing Rate futures, to be reached by March next year, above 3.80%. Early this month, the terminal rate was around 3.20% and priced for December this year.

What’s even more striking than this rise of around 60 basis points is the jump in implied rates for the end of next year. The December 2023 SOFR contract on Friday implied a fed funds rate of 3.45%, 90 bps higher than the 2.55% implied on Aug. 1.

Traders’ are molding a pretty firm ‘higher for longer’ view of the Fed, and thoughts of a pivot next year are evaporating. Only 35 bps of easing is priced in for the back end of next year, down from 60 bps a few weeks ago.

Even though inflation appears to be cooling, Powell was clear that the Federal Market Open Committee is taking no chances.

“The bottom line was that the FOMC’s job is not done, and that it will need to follow through with additional hikes — despite potential economic pain — … and then keep policy restrictive for a time,” economists at Barclays wrote on Friday.

(The opinions expressed here are those of the author, a columnist for Reuters.)

(By Jamie McGeever; Editing by Alistair Bell)

Aug 29 (Reuters) – Euro zone money markets moved on Monday to price in a two-thirds chance of a large 75 basis-point European Central Bank rate hike in September after policymakers made the case over the weekend for a large move to tame inflation four times above their target.

Particularly in focus was ECB board member Isabel Schnabel, who argued that the risk is rising that long-term inflation expectations “de-anchor” from the bank’s 2% target and surveys suggest inflation is denting public trust in central banks.

Others said frontloading hikes would be reasonable and that the neutral rate, estimated around 1.5%, should be reached before year-end or first quarter 2023.

Traders on Monday priced in as much as 67 basis points of rate hikes at the bank’s Sept. 8 policy meeting, meaning they fully priced in a 50 basis-point move and a 67% chance of a 75 basis-point move, Refinitiv data showed.

That compares to a 24% chance of the larger move they priced on Friday, before a Reuters report that some policymakers wanted to discuss the bigger move raised the odds to 48%.

“The most important signal (from Jackson Hole) was from Schnabel who talked about the risk of inflation expectations moving above target, that the central bank would have to hike rates more violently, and that is something new,” said Jan von Gerich, chief analyst at Nordea.

As rate hike bets rose, Germany’s two-year bond yield, sensitive to interest rate expectations, rose as much as 19 basis points (bps) on the day to 1.162%, the highest since June 17.

Its 10-year yield, the benchmark for the euro area, rose as much as 15 bps on the day to 1.548%, its highest in two months.

“The ECB clearly looks with determination to frontload the hikes and this will linger on ahead of the September meeting,” said Piet Christiansen, chief analyst at Danske Bank in Copenhagen, now expecting a 75 bps hike.

ECB chief economist Philip Lane added to the comments on Monday, saying the bank should raise interest rates at a “steady pace” and that appropriate increments will be larger the wider the bank is form peak rates and the more skewed the risks are to its inflation target.

Bond yields eased from the day’s highs as gas prices dropped sharply after Germany’s economy minister said he expects prices to fall as Germany is set to hit its 85% Oct. 1 storage target in early September. Germany’s 10-year yield was up 9 bps by 1350 GMT.

Ten-year yields in Italy, a key ECB stimulus beneficiary, jumped as much as 17 bps to 3.873%, the highest since mid-June, pushing the closely-watched spread to German peers to 236 bps, the highest in a month.

Rohan Khanna, strategist at UBS, said the more front-loaded rate hikes, the more likely the ECB will have to consider activating its Transmission Protection Instrument, under which it will buy bonds from countries whose borrowing costs relative to Germany are rising through no fault of their own.

“The harder the ECB pushes on the rate-hike pedal, the faster we are likely to get to 300 bps on this spread,” he said.

(Reporting by Yoruk Bahceli, additional reporting by Dhara Ranasinghe; Editing by Dhara Ranasinghe, Emelia Sithole-Matarise and Angus MacSwan)

NEW YORK, Aug 26 (Reuters) –  two-year Treasury yields briefly popped to their highest levels since October 2007 before stabilizing near two-month highs on Friday after Federal Reserve Chair Jerome Powell reiterated that the  central bank will continue to raise interest rates to fight inflation.

Powell, in a closely watched speech at the Fed’s Jackson Hole conference, said investors should not expect the central bank to reduce interest rates until inflation is tamed.

“While higher interest rates, slower growth and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses,” Powell said.

The two-year Treasury yield, which typically moves in step with interest rate expectations, was up 2.9 basis points at 3.403%, slightly below its high for the year of 3.4350% in June.

The rise in short-term interest rates further inverted the yield curve, which is often seen as a signal of an upcoming recession. The closely watched gap between yields on two- and 10-year Treasury notes was at -37.0 basis points, compared with -31.3 basis points before Powell’s speech.

The yield on 10-year Treasury notes was up 0.9 basis point to 3.033%. The yield on the 30-year Treasury bond was down 2.7 basis points to 3.207%.

Yields rise as bond prices fall.

“Powell’s comments were remarkably in line with market expectations,” said Ian Lyngen, head of rates strategy at BMO Capital Markets. “Overall, the response is well within the recent range in nominal terms, even if the curve appears biased to break out lower.”

August 26 Friday 1:55PM New York / 1755 GMT

(Reporting by David Randall;
Editing by Chizu Nomiyama, Nick Zieminski and Leslie Adler)