While stock traders have been piling into the Santa rally, bond investors this holiday season have been busily building what some say could be the biggest short position ever in Treasury futures.
That's a massive bet that interest rates will rise.
George Goncalves, head of rate strategy at Nomura, calculated some $29 billion worth of shorts across the Treasury futures complex—the highest level, post-financial crisis.
While it's clear rate expectations are slightly higher for 2015, with the Fed expected to raise rates, Goncalves said the market could be positioning for other events as well, such as European Central Bank easing.
"We've got the ECB meeting Jan. 22. The first week of January we get all of the European inflation data. That's going to really set the tone," he said. The market sees a chance that the ECB could announce a quantitative easing-stylebond buying program, but weak inflation data would reinforce that notion.
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Goncalves said a QE announcement could actually drive yields higher, since the expectations for deflation diminish. The 10-year yield rose after Federal Reserve QE announcements, he said. Bond yields move opposite prices.
Yields have defied expectations all year, with rates at the long end of the curve near the lower end of the 2014 range in recent sessions. The 10-year Wednesday was at 2.26 percent, just below 2.28 percent, a support level traders have been watching.
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Goncalves said the market has been building in expectations for a Fed hike in short-term rates. The yield curve has been flattening as yields rose at the shorter end of the curve, particularly the 2-year. Hedging for that trade could be part of the increase in shorts, he said.
"The bond market is increasingly building in a more aggressive Fed," said Adrian Miller, director of fixed income strategy at GMP Securities. He said the Commodities Futures Trading Commission data on Dec. 16 showed net short positions on 10-year futures totaled 258,000 contracts, the second largest ever behind May, 2010 when there were 275,000.
As of Nov. 25, there were only 75,000 net shorts, and the last time they were net long in 10-year futures was in September, with 8,800 contracts.
"We started rolling into better data, and then we had the employment report. That probably quickened the trade," said Miller. "We can debate all day long how much rates are going to rise. …At the end of the day, it's still going to be a rising rate environment." He said consensus for the 10-year yield for 2015 is 3.06 percent at year end. It was last above 3 percent on Jan. 9.
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While stocks have risen about 6 percent in the past six sessions, the yield on the 10-year has edged higher—from a low of 2.0 percent a week ago when the Fed was meeting.
Bond shorts have been repeatedly disappointed in 2014, and Goncalves said they could be disappointed again.
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"It's hard to get out right short. You only get short three to six months before the Fed hikes. People are debating that they might hike in April or June, but that requires the stars to align. You need to get Europe back on track and oil to stabilize," he said. Getting short, "It's a negative carry trade and you only really can do that when you know they're (the Fed) convinced they're going to hike."
Fed watchers mostly expect the Fed's first rate hike in June or later.