U.S. Treasury futures short positions rise, risk of short squeeze looms

Original author: Bao Yilong

Source: Wall Street Journal

Short positions in U.S. Treasury futures continue to accumulate, and analysts believe that if economic data weakens or Fed officials signal a dovish stance, the market could face a sharp short squeeze.

Wall Street Journal mentioned that U.S. Treasuries extended their months-long decline on Tuesday, pressured by a surge in corporate bond supply, with the 30-year yield rising to its highest level since 2002. Meanwhile, elevated energy prices continued to fuel inflationary pressures, further boosting market bearish sentiment.

However, short positions in U.S. Treasury futures are currently highly concentrated, and any unexpected signal of economic cooling could trigger a sharp unwinding of these short positions, causing a significant short-term decline in yields.

This week, bond traders will focus on two key data releases: the Fed’s preferred inflation indicator, due on Wednesday, and the monthly employment report over the weekend. According to economists surveyed by Bloomberg, non-farm payrolls in September are expected to increase by about 90,000, a significant slowdown from August’s surprise gain of 162,000.

According to CME data, open interest in both 5-year and 10-year Treasury futures has risen significantly over the past two weeks.

According to data from the U.S. Commodity Futures Trading Commission (CFTC), as of the week ending September 22, asset management institutions added over 100,000 short positions in 10-year Treasury futures, marking one of the largest weekly increases since 2023.

Additionally, the 5-year contract saw open interest increase in 11 of the past 12 trading days, while the 10-year contract expanded in 13 of the past 14 trading days.

In terms of scale, since early last week, the combined new futures exposure across the two tenors has amounted to approximately $32 million per basis point, equivalent to the current $75 billion notional value of the 5-year cash bond.

Bank of America strategists, including Meghan Swiber, noted in a research report that:

Futures positions still favor further upside in yields, with short positions remaining profitable across short- and medium-term maturities.

The team also noted that asset managers continue to increase their short positions in U.S. Treasuries, particularly in the medium- to long-term maturities, and that trend signals from commodity trading advisors (CTAs) also indicate they are "firmly maintaining short positions in U.S. Treasuries."

It is worth noting that, behind the current increase in open interest, in addition to directional short positions, there may also be basis trades involving physical government bonds or hedging activities by asset management institutions on their bond holdings, which has somewhat increased the complexity of market structure.

As short-selling pressure continues to build, the market could face a sharp short squeeze if economic data comes in below expectations or Fed officials signal a dovish stance, potentially causing yields to decline rapidly, at least in the short term.

Trends in the options market have confirmed this concern. According to Bloomberg data, over the past week, the skew of long-term bond futures options has shifted sharply, with put option premiums rising to their highest level since August, indicating that traders are actively seeking protection against further yield increases, driving up the cost of puts relative to calls.

Additionally, some bearish hedging positions will expire this weekend, meaning these positions also cover the event risk of Friday’s non-farm payrolls data.

Meanwhile, J.P. Morgan’s U.S. Treasury client survey showed that, as of the week ending September 28, overall investor positioning remained unchanged, with long positions still at their highest level since November last year, indicating that some bullish sentiment persists, providing a potential foundation for short covering.