LONDON (Reuters) - Hamstrung by a renewed slump in volatility and lack of clear market direction, FX and bond speculators are making historically big bets on a lower dollar and higher yields.
It’s an increasingly desperate gamble, particularly on the dollar. Major exchange rates have been constrained within ever-narrowing ranges in recent weeks, and hedge funds’ record bet on the euro simply isn’t paying off.
Their bet on higher long-term U.S. bond yields looks more promising, with the 10-year yield coming within half a basis point on Monday of making the long-awaited break above 3 percent.
Yet the yield curve, whichever way you slice it, is near the flattest in over a decade. Short-dated yields may be the highest since 2008-09, rising in line with the move up in the Fed policy rate, but long-dated yields aren’t rising as fast.
The latest Commodity Futures Trading Commission data show that speculators on the U.S. futures markets increased their net short positions in two-, five-, 10- and 30-year Treasuries, effectively betting on higher yields.
This means hedge funds and speculators are sitting on their fifth-biggest short position ever in 10- and 30-year notes, and the second-biggest short position on record in five-year bonds.
A sustained break in the 10-year U.S. yield above 3 percent will be welcome news for those short Treasuries. But it could be extremely bad news for those doubling down on their short dollar and long euro positions.
Rising U.S. yields are supporting the dollar. A sustained break above 3 pct on the 10-year could have a snowball effect, boosting the dollar’s appeal even further, pushing it higher and forcing specs to bail out of their loss-making short positions.
The latest CFTC data show hedge funds and speculators have increased their short dollar position to the largest since August 2011. It’s a bet now worth some $28.18 billion, according to Reuters and CFTC calculations.
These accounts now hold the biggest net long sterling position for four years and largest net long euro position since the single currency’s introduction in 1999.
The pound has risen against the dollar lately, but the euro has gone nowhere for weeks. It has traded in a range of less than three cents between $1.2210 and $1.2475 for the last seven weeks. Implied FX volatility has slid back to the lows seen before the “volmageddon” burst in early February.
Together, this has triggered a slump in the weekly standard deviation of euro/dollar recently to the lowest since 2010 and the second lowest ever.
Standard deviation measures how closely the price of an asset clusters around the mean over any given period of time. A low standard deviation reflects little variance from the mean; the opposite reflects a wider dispersion.
Low and falling volatility, narrow trading ranges and low standard deviations make a bad mix for hedge funds and speculators, who try to jump on longer-term market trends, exploit price differentials and thrive on volatility.
According to RMG Investment Management, the dollar is poised to break out of its ranges of the past three months and undergo a big move, although it’s not entirely clear in which direction.
“In all free markets, periods of low volatility are followed by high volatility and vice versa. The dollar is on the cusp of an important move. It’s time to sit up and pay attention,” they warn.
Music to hedge funds’ ears. Assuming the move goes their way, of course, and the dollar breaks lower.