Short $1.14 Trillion with Interest Rate Risk

Mobius Intel Brief:

Yields on longer-dated US sovereign debt are surging to multi-month highs in October, raising the dollar to its highest against major economies since early August and exposing risks from leveraged basis trade activity.

• Key Intel: A ‘jumbo’ 50 bps cut at the Fed’s Sep 18 meeting and expectations for near-term inflationary policies have amplified pressure on US sovereign debt, raising yields on 2YR and 10YR notes by more than 50 bps in less than a month.

• Behind the scenes, leveraged hedge funds have amassed the largest short position in US Treasury futures on record at more than $1.14 trillion. Leveraged basis trade volume is nearly 1.5x the levels seen in Sep 2019’s liquidity squeeze and subsequent repo market crisis, inviting the return of ‘feedback loop’ risks reminiscent of August’s yen-funded carry unwind saga.

A closer look at the numbers:

Markets are repricing interest rate expectations after a mix of stronger-than-expected economic data and perceived inflationary policies for US presidential candidates amplified fears that the Fed’s 50 bps cut would reignite price growth.

• Yields on longer-dated US sovereign debt jumped to multi-month highs in response, with yields on 2YR, 5YR, and 10YR Treasuries respectively up 52 bps, 54 bps, and 54 bps since Nov 27 lows.

Repriced interest rate expectations in the US coincide with rate cuts in weaker-performing economies like the EU. The resulting effect on sovereign yield spreads has generated a 3.5% M/M rally for the dollar index.

• The Japanese yen has fared worse than other currency pairs in the dollar index basket, falling to a 12-week low of over 153 per dollar before gaining back to 152.79.

Leveraged Funds Rack Up Record $1.14 Trillion in Notional Shorts

According to the latest traders in financial futures (TFF) data, the notional value of leveraged short interest in 2YR, 5YR, and 10YR T-Note futures gained to more than $1.14 trillion last week — nearly 49% higher than the levels that fueled Sep 2019’s liquidity squeeze and subsequent repo crisis.

• Why it matters: Leveraged basis trades (long cash Treasuries, short Treasury futures) rely heavily on repo financing. Interest rate volatility elevates the risk that leveraged funds will face margin calls after a sudden spike in repo rates — forcing funds to rapidly unwind trades by selling off Treasuries and adding more pressure to bond prices, creating a feedback loop of constrained liquidity, higher interest rates, and more bond selling.

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