Hedge funds are increasing short positions in US equities vulnerable to higher interest rates and weaker consumer demand, reversing a recent wave of short covering as renewed inflation concerns create opportunities for bearish investors, according to a report by Bloomberg citing Bank of America trading data.

Bank of America's short analytics team identified renewed selling pressure in heavily shorted small-cap stocks, with consensus short positions declining 2.47% on Thursday, compared with a 1.4% fall in the Russell 2000 Index. The shift follows stronger-than-expected US inflation data and disappointing existing-home sales, reinforcing expectations that the Federal Reserve could maintain elevated interest rates for longer.

Short sellers had previously generated substantial profits between mid-August and mid-October as rising energy prices and concerns over borrowing costs weighed on rate-sensitive equities. Consumer discretionary stocks were particularly affected, with consensus short positions in the sector declining an average of 16.5% during the period.

However, a subsequent rally saw those stocks rebound approximately 20% between mid-October and early November, triggering widespread short covering as hedge funds moved to protect accumulated profits. The resulting squeeze erased much of the gains from earlier bearish positions.

Recent economic data has prompted managers to revisit those trades. Following the latest inflation figures, heavily shorted consumer discretionary stocks fell an average of 2.28%, compared with a 0.38% decline in the S&P 500, suggesting renewed opportunities for short sellers targeting companies exposed to high financing costs and slowing consumer spending.

John Egan, Bank of America's global head of short analytics and tactical solutions, said the underperformance of heavily shorted stocks supports renewed bearish positioning. However, the shift does not necessarily indicate a broader retreat from equities, with hedge funds simultaneously rebuilding long exposure to technology companies following the recent market correction.