Hedge Funds Head for Cover as Dollar Rebound Gathers Pace

(Bloomberg) -- The dollar rebound is picking up pace, with signs that speculative traders are busy covering short positions after U.S. Treasury yields surged.

Traders are reporting strong demand from leveraged funds for the dollar on Monday, adding to data released from the Commodity Futures Trading Commission that showed them trimming long positions on major currencies including the euro and the pound.

“The dollar is so extremely oversold, over-hated, and over-shorted that it all but has to rally for a while at some point soon,” said Matt Maley, chief market strategist at Miller Tabak + Co. “The dollar is getting very ripe for a tradable bounce -- one that will last at least several weeks and maybe even a couple of months.”

A 20-basis point surge in benchmark Treasury yields last week, the most since June, is spurring a rethink of bearish dollar strategies as markets debate how far yields could rise. Risk sensitive assets, from emerging-market currencies to gold, have all seen pullbacks.

The Bloomberg Dollar Spot Index rose as much as 0.5% to a two-week high, with commodity currencies leading losses. There is no cash trading of Treasuries in Asia on Monday with Japan markets shut.

Leveraged funds cut net long options and futures positions across the euro, the pound and the Australian dollar for the week through Jan. 5, according to CFTC data. They also added to shorts on the New Zealand and Canadian currencies.

Dollar Returns

Investors should brace for more short-term dollar strength ahead as the Democratic Party gains control of Congress, and pushes for more fiscal stimulus, strategists said.

Their agenda will send yields higher, and that may “represent a potential lifeline for USD, especially against low-beta low-yielders,” JPMorgan Chase & Co. analyst Paul Meggyesi wrote in a report Friday. A steepening U.S. yield curve could also be a “temporary headwind” to Goldman Sachs Group Inc.’s short dollar trade recommendations, strategist Zach Pandl wrote in a note.

Expect losses particularly among emerging-market currencies to accelerate should Treasury yields return to pre-pandemic levels, according to Mizuho Bank Ltd.

“Yields will have to move abruptly past the 1.6 to 1.8% range -- in other words, pushing higher than pre-COVID levels -- for a proper scare,” said Vishnu Varathan, head of economics and strategy at Mizuho. “That’s when markets will start worrying.”

Short Treasuries

There is also a growing chorus of recommendations to short Treasuries as reflation concerns brew.

Quantitative hedge funds were busy liquidating loss-making long Treasury wagers last week, and may have begun establishing new short ones as yields breached 1.10%.

TD Securities Inc. recommends shorting 10-year Treasuries with a 1.30% target, a level unseen since February. Citigroup Inc. also called for a trade that will benefit if higher yields drive up low rates volatility.

Others including Standard Chartered Plc are revising their U.S. 10-year targets higher on the Democrats’ control of the Congress.

“This reflects the expectation that the Fed will allow yields to back up as the economy improves, but will not entirely step away from the bond market,” said Steven Englander, head of global G-10 FX research at StanChart, which now expects yields to hit 1.50% by year-end.