The bond market has a crowded trade on right now, and it is making this week's inflation report feel a lot bigger than usual.
A group of trend-following funds known as commodity trading advisers, or CTAs, have built their largest short position on global bonds in decades. A short bet is a wager that prices will fall, and these funds are betting big.
The numbers are striking. A one-basis-point move in 10-year Treasury yields now shifts CTA profits or losses by roughly $300 million. That is the biggest such exposure since UBS began tracking it in 1990.
CTAs manage more than $400 billion in assets, and UBS Group AG reports that these funds ended July with bond underweights three times as large as they had two weeks before. They have kept those bets unchanged since.
That kind of crowding can make markets fragile, because a reversal in bond prices would force many funds to unwind similar trades at once.
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Global government bond yields have climbed recently, pushed up by higher oil prices, expectations of central-bank rate hikes, and worries about governments borrowing more. Last month, 30-year US Treasury yields rose to a level last seen in 2007 and have stayed near that point. Oil remains expensive because tensions between the U.S. and Iran over the Strait of Hormuz are keeping traders nervous.
Here is the problem for these funds: when everyone is on the same side of a trade, there is not much room left to push it further. Phoebe White, UBS's head of U.S. rates strategy, was blunt: "There's not a lot of room to add to short positions."
That one-sided positioning leaves CTAs exposed to sharp losses if bond prices rally instead of fall. White called the situation asymmetric, meaning the downside risk now looks bigger than the potential gain.
The consumer price index report, due Wednesday, could tip the scales. It measures inflation at the consumer level, and this particular report could either support or weaken the case for a Federal Reserve rate hike as soon as September.
Right now, interest-rate swaps put the odds of a quarter-point rate increase next month at roughly a coin toss. That means the inflation data could easily push expectations in either direction.
If inflation comes in hot, it supports the case for a hike. If it comes in cool, it challenges the bears. Bank of America strategists including Meghan Swiber cautioned that if Wednesday's data fails to make the case for a September move, the crowded bearish positioning - large CTA shorts and underweight active funds - could be challenged.
The options market shows similar nervousness. In SOFR options, which track the Fed's key interest rate, the biggest new risk appeared at the 96.25 strike for contracts expiring in September and December 2026. Two Dec26 put strikes, 95.6875 and 95.5625, jumped sharply, with both linked to a put spread that drew heavy buying on Aug. 6 and before. Dec26 puts saw the steepest declines, with a put condor hit by heavy selling.
JPMorgan's client survey for the week ended Aug. 10 showed investors moved from long to neutral, with the net long position at its smallest since May 18.
On Friday, UBS's Phoebe White and her colleagues recommended clients buy two-year notes, citing a softer jobs report, signs inflation has peaked, and the crowded short positioning. "Clearly, the risks are asymmetric," White said.
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