Over 400 billions at stake! Trend funds have set a record shorting global bonds, with this week's US CPI likely to be the key to gains and losses

Trend-chasing investors have pushed global bond short positions to record highs, dramatically increasing the significance of the latest US inflation data. If the data triggers a bond rebound, the massive CTA short positions will face forced closing pressures.

According to UBS, by the end of July, Commodity Trading Advisors (CTAs) aiming to profit from asset price trends had doubled their underweight bond positions compared to two weeks earlier, and have since kept their positions mostly steady. UBS strategist Nicolas Le Roux noted that ahead of the inflation data release, for every 1 basis point move in 10-year US Treasury yields, CTAs face a profit and loss exposure of about $300 million, the highest level measured by UBS since it began compiling such data in 1990.

The US July Consumer Price Index (CPI) report, to be released on Wednesday night Beijing time, will serve as the most direct market catalyst. The data could reinforce or weaken expectations that the Federal Reserve will raise rates as early as September, forcing traders to readjust their positions. Interest rate swap contracts show the market currently sees the probability of a 25 basis point Fed rate hike in September as roughly fifty-fifty.

In recent months, persistently high oil prices, continued expectations of central bank rate hikes, and expanding government borrowing have driven global government bond yields ever higher. Last month, the yield on 30-year US Treasuries hit its highest level since 2007 and has remained near those highs. The ongoing bond sell-off has prompted CTAs to further ramp up their short bets, and this group manages an estimated $400 billion in assets.

However, the high level of position concentration also creates clear reversal risks. Phoebe White, Head of US Rate Strategy at UBS, said: "There is little room to further increase short positions, and the risks are clearly asymmetric." She pointed out that if bonds rally, traders are much more likely to cover shorts than to add further to positions if bond prices fall again.

Bank of America strategists have similarly noted the extreme bearish positioning among CTAs, pointing out that this group is currently "heavily short," especially in short-dated bonds.

On Monday, Bank of America strategists including Meghan Swiber wrote in a research note: "If the data does not support a September rate hike, it could pose a challenge to crowded bearish positions, especially given the large CTA shorts and active funds being underweight as well."

Last Friday, after nonfarm payroll data came in weaker than expected, Phoebe White and her colleagues advised clients to buy two-year US Treasuries. Her bullish view is based on two points: first, signs that inflation may have peaked; and second, the current heavily crowded short positions themselves, which could add further fuel to a bond rebound.

Several positioning indicators suggest investor sentiment is becoming more cautious. For the week ending August 10, JPMorgan's US Treasury client survey showed investor positioning had shifted from net long to neutral, with net long positions falling to their lowest level since May 18.

In the SOFR options market, most of last week’s new risk exposure concentrated at the 96.25 strike price, led by December contracts; meanwhile, relevant strike price positions associated with the August 7 sold put option combinations sharply declined, reflecting that, after the softer nonfarm payroll data, some traders have actively reduced their bearish exposures. Additionally, after last week’s surge in put demand, the cost to hedge via Treasury futures has stabilized.