Markets Signal Higher for Longer Interest Rates

July 20, 2023 |
2 minute read
|

Market sentiment on bonds continues to trend lower, leaving the overall open interest in short-dated U.S. Treasury futures net short at an unprecedented level. There is the potential that these short positions will be under pressure unless a higher-for-longer rate environment sustains.

Open interest, or the outstanding contracts held by commodity trading advisors (CTAs) registered with the Commodity Futures Trading Commission on U.S. Treasury futures is one indicator of broad market sentiment towards interest rates. The futures markets provide investors and speculators with a liquid market to express a view on the direction of the equity and fixed income markets. When there is a net short interest rate position, it indicates investor expectations of higher rates (given the inverse relationship between price and yield). Over the last two decades, open interest has been mostly range-bound between a net long/short position between +/-300 thousand futures contracts. More frequent and longer sustained episodes of net short positions are a product of investors’ expectations of a “higher-for-longer” interest rate environment.

Market positioning indicates CTAs have become comfortable with the notion of a sustained period of higher interest rates. This Chart of the Month displays the open interest on 2-year treasury notes, which are the most traded tenor on the short end of the U.S. Treasury curve. Episodes of rapid increases in the number of short contracts on bonds (evidenced by significant downturns in the chart) have become more severe and frequent in recent years as the use of U.S. Treasury futures to express a speculative view on rates has increased. 

Since 1993, the volume of short contracts has spiked, moving the size of the short position more than one standard deviation below the 20-year average 15 times—all within the last six years. Drifting even further from the 20-year average, the short position has grown to two standard deviations three times—all within the last five years. Taking an even more extreme case, the short position has grown to three standard deviations from the 20-year mean three times in the past eight months as the expectation for higher rates became more ingrained throughout 2022 and has yet to recover.

As of mid-July, the current open interest sits close to six standard deviations from the 20-year average. At this unprecedented level the traders holding bond shorts are poised for a squeeze should interest rates fall. In the wake of the generally positive CPI report in June, short bonds could be a precarious position should the FOMC choose to hold rates in a week. That said, more hikes are expected given the FOMC’s most recent Summary of Economic Projections and that more dovish FOMC officials have recently called for one or two more hikes. Regardless of the FOMC’s future rate decisions, such a staggering short position must be noted and is another example of the volatility that persists in rates markets.

Chart1-COM-07182023-Markets-Signal-Higher

 

Arjun Sawai

Author

Arjun Sawai

Associate

Arjun Sawai

Author

Cameron Dyer

Disclaimer

Certain information contained herein has been obtained from or is based on third-party sources and, although believed to be reliable, has not been independently verified. Such information is as of the date indicated, if indicated, may not be complete, is subject to change and has not necessarily been updated. No representation or warranty, express or implied, is or will be given by The Common Fund for Nonprofit Organizations, any of its affiliates or any of its or their affiliates, trustees, directors, officers, employees or advisers (collectively referred to herein as “Commonfund”) or any other person as to the accuracy or completeness of the information in any third-party materials. Accordingly, Commonfund shall not be liable for any direct, indirect or consequential loss or damage suffered by any person as a result of relying on any statement in, or omission from, such third-party materials, and any such liability is expressly disclaimed.

All rights to the trademarks, copyrights, logos and other intellectual property listed herein belong to their respective owners and the use of such logos hereof does not imply an affiliation with, or endorsement by, the owners of such trademarks, copyrights, logos and other intellectual property.

To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated herein. Forecasts of experts inevitably differ. Views attributed to third-parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Market and investment views of third-parties presented herein do not necessarily reflect the views of Commonfund, any manager retained by Commonfund to manage any investments for Commonfund (each, a “Manager”) or any fund managed by any Commonfund entity (each, a “Fund”). Accordingly, the views presented herein may not be relied upon as an indication of trading intent on behalf of Commonfund, any Manager or any Fund.

Statements concerning Commonfund’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Fund. Such statements are also not intended as recommendations by any Commonfund entity or any Commonfund employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information or statements. Past performance is not indicative of future results. For more information please refer to Important Disclosures.

Stay connected with the Insights Blog

Popular Blog Posts


Market Commentary | Insights Blog

Chart of the Month | U.S. Budget Deficit Hits Record Highs

In his first 100 days as President of the United States, Joe Biden has introduced three domestic funding proposals, totaling close to $6.0 Trillion, reflecting a desire to enhance the role of the...
Investment Strategy | Insights Blog

Key Factors in Asset Allocation Decisions for Endowments

There are several broad subjects that an effective investment policy statement (IPS) should include in its contents and address clearly and specifically as they relate to an endowed institution. This...
Perspectives | Insights Blog

The Case for Using the Higher Education Price Index® (HEPI) to Define Inflation for Colleges

When calculating return targets for an endowment portfolio, a conventional piece of the equation is often the Consumer Price Index (CPI). CPI plus 5% is the common short-hand formula for institutions...

Disclaimer

Certain information contained herein has been obtained from or is based on third-party sources and, although believed to be reliable, has not been independently verified. Such information is as of the date indicated, if indicated, may not be complete, is subject to change and has not necessarily been updated. No representation or warranty, express or implied, is or will be given by The Common Fund for Nonprofit Organizations, any of its affiliates or any of its or their affiliates, trustees, directors, officers, employees or advisers (collectively referred to herein as “Commonfund”) or any other person as to the accuracy or completeness of the information in any third-party materials. Accordingly, Commonfund shall not be liable for any direct, indirect or consequential loss or damage suffered by any person as a result of relying on any statement in, or omission from, such third-party materials, and any such liability is expressly disclaimed.

All rights to the trademarks, copyrights, logos and other intellectual property listed herein belong to their respective owners and the use of such logos hereof does not imply an affiliation with, or endorsement by, the owners of such trademarks, copyrights, logos and other intellectual property.

To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated herein. Forecasts of experts inevitably differ. Views attributed to third-parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Market and investment views of third-parties presented herein do not necessarily reflect the views of Commonfund, any manager retained by Commonfund to manage any investments for Commonfund (each, a “Manager”) or any fund managed by any Commonfund entity (each, a “Fund”). Accordingly, the views presented herein may not be relied upon as an indication of trading intent on behalf of Commonfund, any Manager or any Fund.

Statements concerning Commonfund’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Fund. Such statements are also not intended as recommendations by any Commonfund entity or any Commonfund employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information or statements. Past performance is not indicative of future results. For more information please refer to Important Disclosures.