Over the past few weeks, we have noticed an interesting development in the US interest rate market. Since the beginning of the year, the 2-year interest rate has constantly been increasing on the back of a tightening monetary cycle ran by US policymakers; it is now trading at 2.65%, up from 2% in early January. However, the CFTC Commitment of Traders report shows that speculators have not followed the trend and have been reverting their positioning since January (as opposed to the 10Y positioning). As we can see it on the chart, total net specs positions increased from -329K contracts on January 30th to -19K last week (July 17th) on the back of a sharp reduction in shorts from -735K to -492K and some increase in longs (+67K), hence completely diverging from the 2Y yield. What generated this sudden reversal? We think that the rise in the 2Y may be done and that the short end of the curve could settle around the current levels for a while.
After two hikes this year, the Fed Funds rate currently stands at 2%, and another two moves are expected according to market participants for the rest of 2018 (at the September and December meetings). With the US economy expected to grow at 4.5% in real terms in the second quarter according to GDPnow forecasts, US policymakers have benefited from strong momentum in US fundamentals and a dull summer market with the 10Y yield trading quietly below 3% and equities steadily recovering from their February lows. The SP500 index is up 300pts from its low reached on Feb 9th, and currently trades 50pts away from its all-time high reached in January prior the equity rout. Even though financial markets have still got to ‘face’ the August low-liquidity period, which is the most volatile month if we look at the past twenty years, US policymakers have got all the conditions not to disappoint market participants in the following FOMC meetings.
However, we think that much of the action concerning US monetary policy has been priced in by investors, and we can’t see any more hawkish surprises coming in the following months. Therefore, the 2Y may stabilize around its current level at 2.7%, which could explain the reversal in the specs positions. It will be interesting to see how the short-end and the long-end of the curve react to a sudden rise in uncertainty by the end of the summer, pushing down drastically the probability of a hike at the September meeting.
Chart. 2Y US yield vs. CFTC Specs Positioning (Source: Reuters Eikon, CFTC)