Short Interest Spikes On Major Bond ETFs Ahead Of Fed Meeting

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The Federal Reserve is widely expected to raise interest rates at its coming meeting next week and short sellers in the bond market are positioning accordingly.

According to data by S3 Partners, a financial analytics firm, short interest on three closely watched fixed-income exchange-traded funds spiked by 33% in the latest week, rising to $8.5 billion from $6.4 billion. That move coincided with a sharp uptick in expectations that the Fed would move on rates at its March meeting, which will be held on March 14-15.

When an investor shorts a security, it is a bet that it will decline in price. In this case, it is also a bet that bond yields, which move inversely with bond prices, will rise as they have been of late.

Short interest on the iShares iBoxx $ High Yield Corporate Bond ETF HYG, >+0.10%  rose by 31% to $5.32 billion in the latest week, nearing a historical high of $5.5 billion hit November 2016. The fund “should top that figure by over $1 to 2 billion if short demand continues at this rate,” S3 Partners wrote in a report.

Short interest rose 65% to $1.06 billion on the iShares iBoxx $ Investment Grade Corporate Bond ETF LQD, >+0.13% The iShares 20+ Year Treasury Bond ETF TLT, >+0.29%  saw short interest rise 25% to $2.18 billion in the latest week.

“If the Fed Funds implied probability of March 15th hike remains above 95%, a relative certainty, short selling in these three ETFs should continue,” S3 wrote in a report.

Currently, there is a 98% likelihood that the Fed will raise rates next week, according to S3 Partners’s estimates. That is up from 52% as of Feb. 28.

S3 Partners
A chart looking at ETF short interest on three different fixed-income funds versus the probability of an interest-rate increase at the Fed’s March 15 meeting.

The shift in forecasts came after Federal Reserve Chairwoman Janet Yellen on March 3 said raising rates in March “would likely be appropriate” if employment and inflation data continued to “evolve in line with our expectations.” On Wednesday, the ADP report on private-sector employment showed 298,000 jobs added in February, the third-strongest monthly rate of the economic recovery. The data was seen as cementing the probability of the Fed’s move.

Since the start of March, the iShares high-yield ETF is down 1.6% while the investment-grade corporate bond fund is down 2%. The long-dated Treasury fund has lost 3.4%.

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