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[LTCM]

NEW YORK (Dow Jones)--Hedge funds and other speculative investors turned bullish on the benchmark 10-year Treasury notes for the first time in 20 months, as many participants caved in to a rallying bond market.

The difference in bets on gains in bond prices over those on the opposite trade was 63,000 for the period ended Aug. 31, according to the latest weekly data from Commodity Futures Trading Commission. It was the first time the differential turned positive since January 2009.

Worries about the economy have fueled investors of all strips to seek safety in low-risk U.S. government debt over the past few months. That was a sea change from earlier this year when optimism on the economic recovery gained traction.

The significant shift from such short-term investors, whose trading positions are adjusted frequently and swiftly, is a double-edged sword for the U.S. government bond market.

Robust demand helps push down long-term interest rates, reducing borrowing costs for the U.S. government, consumers and companies at a time when the economic recovery shows signs of wavering. However, the dramatic change in the trading positions raised concern that bond prices could suffer a setback with volatile swings in the short term as the Treasury rally has pushed bond yields to near record low levels, a sign that the market is getting expensive.

"We are seeing capitulation," said Jeff Michaels, co-head of fixed income at Nomura Securities International in New York. "There are more bets on gains in bond prices than any time in the cycle at the worst valuations."

The 10-year note's yield, which moves inversely to its price, traded at 2.621% Tuesday. The yield, a benchmark for consumer and corporate borrowing, has dropped sharply after briefly rising above 4% in early April.

The significant decline in bond yields has pushed many bond bears to switch camp. Bond fund giant Pacific Investment Management Co., which bet against long-dated Treasurys earlier this year, has snapped up bonds since May, noting that the economic recovery is going to be weaker than previously thought.

Morgan Stanley, among the biggest bears on Wall Street, slashed its forecast on the 10-year note's yield more than 200 basis points from the first quarter. The company now sees the yield to end this year at 3%.

Some prominent hedge funds managers, including Paolo Pellegrini and Stanley Druckenmiller, had to cover wrong bets against the Treasury market.

But William O'Donnell, head of U.S. government bond strategy at RBS Securities Inc in Stamford, Connecticut, said that the CFTC's data signals that the buying Treasurys trade is getting "crowded."

Indeed, over the past week, the 10-year note's yield has bounced off the recent trough of 2.418% hit on August 25, the lowest level since January 2009. Last Friday, a better-than-forecast U.S. key non-farm payroll report pushed the 10-year note's yield up by nearly 10 basis points.

To push the 10-year note's yield below 2.418%, the market needs to be fed by much worse economic data in coming weeks, said O'Donnell. Should upcoming data beat investors' expectations and reduce worries about a double-dip recession and deflation, bond prices could fall in the short term, he said.

Another risk would come from the Federal Reserve, some market participants said. Many investors had piled on to the Treasury market betting that the central bank may conduct large-scale Treasury purchases in coming months to stimulate the economy. Should data reverse such expectations, this could also spur selling in Treasurys in the short term, they said.

"We feel the bond market is much more free to selloff than at any point in the cycle," said Nomura's Michaels. "We are not long-term bearish on rates, but short term, we simply don't like the risk/reward of trading from the long side."

http://online.wsj.com/article/BT-CO-201 ... 10656.html