Wall Street Dealers' Unprecedented 'Simultaneous Net-Short in Corporate and US Treasury Bonds'

For the first time in history, primary dealers on Wall Street have taken an unprecedented net-short position in both the corporate bond and US Treasury markets, simultaneously demonstrating market concerns and structural changes. For the first time since statistics began in 1998, dealers are recording a net short in corporate bonds totaling $4 billion (about 6 trillion won), and an unusual shift to a net-short position has also been observed in the US Treasury market, the world's largest bond market. This is in stark contrast to 2017, when institutions hoarded an average of $16 billion in corporate bond inventory, meaning that major Wall Street dealers are selling more exposure to the market than they actually hold.

Directional Bets Amid Geopolitical Instability and AI Infrastructure Investment

The massive short position in the corporate bond market stems from macroeconomic vigilance over geopolitical instability and a high-interest-rate environment. Currently, the corporate bond yield spread over US Treasuries is recording its lowest level in decades, averaging just 0.74 percentage points, giving dealers little incentive to take on default risk.

Accordingly, dealers have taken a massive short position of $13.7 billion on long-term corporate bonds with an average maturity of 5 years or more, which are sensitive to interest rate changes. On the other hand, they have built a long position (net buying) of $9.66 billion in short-term corporate bonds. This is supported by the recent phenomenon of investment demand being concentrated on short-term bonds, as short-term corporate bond issuance continues for the purpose of raising funds for AI infrastructure expansion.

$38 Trillion Treasury Pressure… Exposure of Structural Limitations in the US Treasury Market

Dealers are facing limits not only in the corporate bond market but also in the US Treasury market. Dealers, who had maintained a net-buying stance for a long time since the 2008 financial crisis, have recently turned to a net short on US Treasuries as well. This is because while US national debt has surpassed $38 trillion and the volume of Treasury issuance is pouring in, dealers' balance sheets are unable to handle it due to capital constraints caused by regulations. This suggests that traditional intermediary institutions are finding it increasingly difficult to digest the massive supply in the market.

However, this inventory shortage does not simply mean market fear or panic. Thanks to the rapid electronification of the market structure, dealers are now able to efficiently handle customer orders without accumulating massive inventory.

Currently, 49% of investment-grade corporate bond trading and 32% of high-yield bonds are executed via electronic trading, and the proportion of portfolio trading, which buys and sells baskets of multiple bonds at once, has also rapidly increased to 11.8% of total trades. Market experts, including Citadel Securities, assess that the bond market is redistributing risk much more efficiently than in the past.

Warning of 'Asymmetry Risk'

However, experts strongly warn of the 'asymmetry risk' inherent in the current massive short positions. Pension funds and insurance companies, the main buyers of long-term bonds, continuously reinvest their portfolios based on high yields, creating strong demand, but rarely put their holdings up for sale in the market.

If the US Federal Reserve (Fed) halts interest rate hikes or bond yields fall in the future, dealers will have to rush to buy bonds to cover their short positions (short covering). In a market environment with limited supply, if such short-covering buying pressure is added, there is a risk that it will amplify an explosive rally in bond prices, causing a seemingly stable market to fluctuate in an instant.