The U.S. Treasury market is caught in a rare tug-of-war between bulls and bears: quantitative funds have already built large short positions in Treasuries, while active funds continue to trim the long-duration exposure they had accumulated earlier.

In its latest report, JPMorgan argues that short-term Treasury yields still face upward pressure, and the ongoing duration reduction by discretionary investors may outweigh the reversal risk created by extreme CTA shorts.

On one hand, CTA bearishness on Treasuries has become very crowded, which means that if yields turn lower, short covering could drive a rapid rebound in Treasury prices. On the other hand, active bond managers control far more assets than quantitative funds, and their continued reduction of long-duration positions could still generate greater real selling pressure on Treasuries.

At the same time, although risk-parity funds have room to increase Treasury allocations, elevated bond volatility is limiting how quickly they can add exposure. Therefore, before discretionary funds finish adjusting their positions, JPMorgan still leans toward the view that Treasury yields are more likely to keep rising in the short term rather than fall.

CTA Treasury Shorts Have Reached Extremes, Raising Reversal Risk

Quantitative strategies performed strongly in September. Managed Futures/CTA funds returned about 4.29% for the month and 14.34% cumulatively in the first nine months of the year, making them one of the best-performing strategies; Macro Quant funds returned 3.41% in September and 11.27% year to date.

This strong run in quantitative strategies was driven in large part by trend trading in bond futures. JPMorgan's trend-following model shows that as of September 30, the momentum signal for U.S. Treasury futures had fallen into an extreme negative range, with a z-score near -2.5 to -3.0.

When the momentum signal reaches this level, it means CTA bets on falling Treasury prices have become quite crowded. As long as Treasury yields continue to rise, trend strategies may still profit along the way; but if yields begin to fall, a reversal in the trend signal could force CTAs to take profits, cover shorts, or even turn long, further amplifying the rebound in Treasury prices.

Discretionary Funds Are Still Cutting Positions, Keeping Pressure on Treasuries

In contrast to quantitative funds, the long-duration positions accumulated earlier by active investors have not yet been fully unwound. The 20 largest active bond mutual funds in the United States still had duration betas at historically high levels recently; U.S. balanced mutual funds also had bond duration betas above historical averages, though they have already begun actively compressing them in recent months.

JPMorgan's U.S. Treasury client survey also shows that real-money investors still hold persistent net long duration positions. This means active funds currently not only lack the incentive to add more Treasury exposure, but also need to continue reducing the duration risk accumulated earlier.

This adjustment is also present in the European bond market, but for Treasuries, the key point is that discretionary bond managers control far more capital than CTA funds. Therefore, even if CTA short positioning has already reached extreme levels, the potential short-covering bid may not be enough in the short term to offset the selling pressure from active funds continuing to cut positions.

Risk-parity funds could theoretically become potential buyers. JPMorgan estimates show that implied leverage for such funds is currently below historical averages, leaving room to increase bond allocations. However, as Treasury volatility continues to rise, the pace at which risk-parity strategies can add exposure is constrained, making it difficult for them to form a sufficiently strong bid for now.

Therefore, the core issue in the current Treasury market is not whether shorts have become excessive, but that extreme CTA shorts and the unfinished duration reduction by discretionary funds are occurring at the same time. With the latter still dominant, JPMorgan expects Treasury yields to remain biased upward in the short term; but as CTA shorts build further, reversal risk in the market is also rising alongside yields.