Short positions in U.S. Treasury futures continue to build, with open interest in both 5-year and 10-year contracts reaching new highs, setting the stage for a potential short squeeze. If PCE or non-farm payrolls data weaken, the crowded short positions could trigger a concentrated cover, leading to a rapid decline in yields.
Short positions in the U.S. Treasury market are becoming crowded. Over the past several weeks, open interest in 5-year and 10-year U.S. Treasury futures has continued to rise, as traders bet that yields will rise further from their multi-year highs.
But this also leaves another possibility: if economic data suddenly weakens or Fed officials signal a dovish stance, the accumulated large short positions could be quickly covered, driving yields lower in the short term.
This week’s PCE inflation and non-farm payrolls data will serve as key catalysts. Markets are first awaiting the PCE, the Federal Reserve’s preferred inflation indicator, to be released on Wednesday, followed by the September non-farm payrolls report on Friday, with economists expecting around 90,000 new jobs—significantly lower than the unexpected increase of 162,000 in August.
Short positions on U.S. Treasuries continue to increase
According to data from the Chicago Mercantile Exchange (CME), the open interest in 5-year U.S. Treasury futures increased on 11 of the past 12 trading days, while the open interest in 10-year contracts increased on 13 of the past 14 trading days.
Over the week ending September 22, asset management firms increased their short positions in 10-year U.S. Treasury futures by over 100,000 contracts, marking one of the largest weekly increases since 2023.
Strategists at Bank of America, including Meghan Swiber, wrote in their report: "Futures positions remain biased toward higher yields, and short positions remain profitable across short- and medium-term maturities."
They noted that asset management firms continue to increase their short positions in medium- to long-term U.S. Treasuries, and trend-following commodity trading advisors also show a "firm short position on U.S. Treasuries."
Since early last week, the combined new futures exposure for the 5-year and 10-year maturities has totaled approximately $32 million per basis point, equivalent to about $75 billion in current 5-year U.S. Treasury spot holdings.
These trades may also include basis trades against spot U.S. Treasuries and hedging activities by asset management firms for their bond portfolios, in addition to direct bets on rising yields.
The more concentrated the short positions, the larger the potential volatility during a reversal. If employment data significantly undershoots expectations, or if Federal Reserve officials signal a more dovish stance, short covering could drive yields down rapidly.
The 30-year U.S. Treasury yield has risen to its highest level since 2002.
Meanwhile, selling pressure on long-term U.S. Treasuries continues to intensify. The 30-year U.S. Treasury yield rose above 5.61% on Tuesday, marking its sixth consecutive trading day of increases and reaching the highest level since 2002.
Inflationary pressures, rising energy prices, and a large volume of corporate bond issuances are increasing pressure on long-dated U.S. Treasuries. The launch of a $32 billion investment-grade bond offering by Paramount Skydance Corp. also became a key supply factor attracting market attention that day.
Monty Gandhi, interest rate strategist at Sumitomo Mitsui Banking Corporation (SMBC), said this was the fifth-largest investment-grade bond transaction on record, and "the move in the long end may be related to this."
The U.S. Treasury market has a size of approximately $32 trillion, declining 2.6% year-to-date after rising 6.3% last year. The 10-year yield is currently around 5.25%, nearing its highest level since 2007; the 2-year yield remains the last among major maturities to stay below 5%.
Michael Cloherty, Head of U.S. Interest Rate Strategy at CIBC Capital Markets, said that long-dated U.S. Treasuries appear cheap by historical standards, but high yield levels have not yet attracted significant value buyers.
“We’ve been waiting for over a month, and they’re nowhere to be found,” Klochti said.
Interest rate hike expectations versus employment data tug-of-war
Rising energy prices led markets to bet on further Fed rate hikes, pushing up U.S. Treasury yields. Markets initially anticipated at least one 25-basis-point hike by year-end, possibly as early as the October meeting, and expected nearly three additional rate hikes by mid-2027.
However, remarks by New York Fed President Williams on Tuesday tempered some expectations for further rate hikes. He stated that it “may be appropriate” for the Fed to “raise the target range” for interest rates again later this year to curb inflation.
The two-year U.S. Treasury yield, which is more sensitive to policy expectations, fell by 5 basis points immediately after Williams' speech and later stabilized around 4.89%.
Dan Carter, Senior Portfolio Manager at Fort Washington Investment Advisors, said Williams’ remarks present a “quite stark contrast” to “many other Federal Reserve speakers,” who previously conveyed a sense of urgency regarding further rate hikes.
Carter believes that market expectations for an October rate hike could remain at least until Friday, when the U.S. September non-farm payrolls report will be released.
Economists expect non-farm payroll employment to increase by approximately 90,000 in September, below the 162,000 recorded in August. If the data significantly undershoots expectations, the currently crowded U.S. Treasury short positions could face repricing.
There is still supply and seasonal pressure in October.
In addition to monetary policy, U.S. government debt levels, corporate financing needs, and the unwinding of yen-funded carry trades are also influencing the U.S. Treasury market.
Citigroup strategists believe that carry trades involving borrowing yen to invest in high-yield assets are being unwound, driving selling pressure in U.S. Treasuries. Yardeni Research also views the unwinding of yen carry trades as one of the factors behind recent bond selling.
However, some investors have begun to see the opposite opportunity. Wall Street investor Jim Bianco has turned bullish on U.S. Treasuries for the first time in six years, while long-term bond investor Chris Iggo believes bonds may rebound after four consecutive years of challenges.
Mark Dowding, Chief Investment Officer at RBC BlueBay Asset Management, believes that the global bond market sell-off has gone too far.
Seasonal factors may also continue to pressure the U.S. Treasury market in October. Bloomberg data shows that over the past decade, the median decline for U.S. Treasuries was 0.9% in September and 0.7% in October.
Prashant Newnaha, strategist at TD Securities, said: "The September interest rate market was a disaster, and painful trades may continue." He noted that as long as the Middle East situation remains unresolved, fixed-income markets could still face ongoing de-risking.
Masahiko Loo, Senior Fixed Income Strategist at State Street Global Advisors, said October is typically a "seasonal stress period" for U.S. Treasuries, as investors return from the summer lull, and increased Treasury supply, heavy corporate bond issuance, and AI-related capital expenditure demands continue to compete for limited capital.