Expect curve steepening

A look at long-term trends of commercial interest in the CFTC’s “Commitments of Traders” report
Expect curve steepening

Expect curve steepening

The post-Brexit and non-FOMC action in the U.S. interest rate futures clearly shows that commercial traders are expecting the yield curve to begin steepening towards the fourth quarter. We’ve seen this through the ramping up of open interest in Eurodollar futures as the market tests the long-term averages now between 98.60 – 98.80 in the December contract. 

A commercial net position surpassing the June total of 1.28 million would confirm a push towards new highs. The same can be said of the five-year Treasury note as commercial traders continue to maintain a net long position near 250,000 contracts. Watch December’s all-time net long record at 451,000 and a total position of 3.94 million (currently at 3.76 million) for confirmation of the upward trend on the short end of the yield curve.

Meanwhile, moving out to the 10-year Treasury note we see commercial traders have been net sellers in seven out of the last nine weeks. This brings their net short position to its most bearish levels since December of 2012. Finally, moving to the 30-year Treasury bond, we see commercial traders setting a new net short record position, surpassing their record short position from January of 2008. Perhaps, just as importantly, large speculators have set a new net long record in the 30-year Treasury bond. History has shown that speculatively fueled moves end abruptly once they quit attracting new money.

An interesting disconnect appears to be taking shape regarding the economic outlook. Interest rate action suggests near-term slack with an inflationary eye toward the future. However, the commercial traders’ actions in the metals clearly indicate that they expect precious metals’ prices to be lower into fall, if not longer. The battle taking place between the speculators and commercial traders in the metals is on full boil. Speculators have set new, net long record positions in gold, silver and platinum. Commercial traders have matched their moves in gold and silver but have yet to set a new, record short position in platinum. Just to put this into perspective, speculators are now long 12.5 contracts of silver for every contract they’re short compared to long 8.9 gold contracts for every short and long 6.5 platinum contracts for every short. 

This is a great insight into the battle over fundamental price discovery versus overly confident speculative traders attempting to front run inflation and the Fed. 

Moving to the softs, this is a transition year for sugar as it shifts from years of surplus to deficit production. Obviously, declining supply is bullish but, the commercial traders--who’ve dominated this market this year--believe that there may be another leg lower first. Commercial selling on the recent rally began in earnest as the market breached 16.5¢ per pound, and appears to have climaxed at a record short position above 350,000 contracts as it topped out at more than 21¢. This selling cannot take place without denting the sugar futures’ recent rally. Long-term averages come in between 15.5¢ and 16.3¢ in the October contract. A test of these levels as a result of the significant commercial selling pressure could be a good buying opportunity as the market transitions to deficit near its mid-September seasonal low.

About the Author

Andy Waldock, owner of the brokerage firm Commodity & Derivative Advisors and the subscription service COTSignals.com, is a third generation commodity trader with over 25 years of experience on all of the main U.S. exchanges.