The central bank is causing the bond turmoil it causes to big-name hedge funds – News Couple

The central bank is causing the bond turmoil it causes to big-name hedge funds

The era of unlimited generosity of the central bank is drawing to a close, injecting extreme volatility into government bonds and inflicting severe damage on a host of high-profile hedge funds.

Industry stars have been left with billions of dollars in losses after a sudden rethink of how and when central banks will reverse the massive wave of support they provided to markets when the pandemic hit last year.

At first, central banks said this process would be too slow, despite rising inflation, and hedge funds believed it. But markets began to worry last month that the US Federal Reserve and other central banks would have to raise interest rates more quickly, offending high-profile traders including Chris Ruckus and Crispin Audi.

A massive sell-off of short-term government debt has upended some of these funds’ biggest bets, exacerbating market volatility by rapidly exiting their positions. Rubbing salt into the wounds, some of those bets later proved to be true all along. The repeated strikes indicate that markets will remain difficult to negotiate as central bankers choose their way out of crisis mode.

“There was very little blood on the streets,” said Mark Dowding, chief investment officer at BlueBay Asset Management, which specializes in bonds.

Macro hedge fund managers Mayfair and Wall Street have long bemoaned trillions of dollars of central bank purchases sweeping the markets, which they said have quelled the big shifts they seek to profit from. Judging by a string of recent losses, the industry has had to be careful about what it wishes for.

A person familiar with the figures said London-based Roccus Capital, which manages $12.5 billion in assets, lost about 18 per cent last month. That leaves the fund, headed by billionaire bond market specialist and former Brevan Howard co-founder, Ruckus, down more than 26 percent this year. Losses at New York-based Alphadyne Asset Management, which focuses on total and fixed income, have left it down 17 percent this year. Crispin Odey, one of Europe’s best-known managers, has lost nearly 50 percentage points of performance in Odey’s European fund since early October, although it has remained up about 59 percent this year.

The blame is the bond market turmoil that began in late September when the Bank of England first hinted that it might raise interest rates before the end of the year in an effort to curb rising inflation. The move surprised market participants who had long assumed such a move was off the table until mid-2022. The spark from the gold market quickly ignited an inferno across global bond markets, aided by hawkish moves from Australian and Canadian central banks.

With Wednesday’s announcement that the Fed’s bond purchases will begin to cut back, traders are beginning to bet that the world’s most powerful central bank will have to follow suit by raising interest rates earlier than expected.

Indeed, the Fed announced a gradual reduction in its asset purchase program, but issued a cautious note about eventual rate hikes. The next day, the Bank of England delivered a much bigger shock by refusing to raise interest rates at all, sending government bond prices up and lowering government bond yields in other countries as well.

The jolt in the bond markets has proven painful for investors who are usually seen as market experts. “The hawkish shift from most central banks – perceived or explicit – in response to recent high inflation prints and expectations has surprised many market participants,” said Tom Brickett, co-head of interest rate trading for Europe at JPMorgan.

The rush to losing bets has forced some investors to accept prices that are less favorable than they would have done in normal market conditions. Briquette said the gap between dealers’ buying and selling prices – a measure of how easy it is to trade the market – has widened to “up to three to four times” levels typical in some interest rate markets.

Among other funds that lost money in the volatility, $13.5 billion in assets was ExodusPoint Capital, which has about half its risk in bonds and which lost 2 percent. In emerging markets, which also felt the quake, New York-based Robert Gibbins Autonomy Capital lost about 7 percent, bringing losses this year to 28 percent. The fund took bad bets in the bond markets of the United States, Brazil and China. London-based Pharo Management lost 2.4 percent in its $5.3 billion Gaia fund and 2.7 percent in its $4.9 billion Macro fund, sending it down more than 10 percent this year, people familiar with the performance say.

Industry insiders say the money faltered because of the way they placed their bets. Some had been expecting central banks to allow inflation to rise for some time without raising interest rates, and they bought short-term bonds outright.

“Central banks were 100 per cent wrong,” said one senior hedge fund trader who avoided chaos. “They didn’t expect inflation and people listened to them.”

Others have placed so-called curve trades – bets that long-term yields will rise faster than short-term yields as inflation erodes the value of long-term debt. Audi recently wrote to clients to say that “if the bond market is to reverse inflation,” the 30-year Treasury, which currently yields just under 2 percent, should yield 4.3 percent.

Line chart of the 2- to 10-year Treasury yield gap (percentage points) showing counterproductive investor bets on a steep yield curve

Deals like this proved disastrous, because expectations of higher interest rates gathered too quickly, driving down prices for short-term bonds, driving up yields and flattening the curve. This flattening indicates that market participants believe that central bank tightening may stifle economic recovery and even end up in a rapid reversal.

“I think the markets are telling you that global central banks are heading towards making a very big policy mistake,” said Gregory Peters, head of multi-segment and strategy at PGIM Fixed Income.

In a sign of these concerns, the price of UK 30-year government bonds, on which Audi had previously bet heavily, has risen since mid-October, sending yields lower. Some funds were also hit with incorrect bets that bond market volatility will remain lower than stock market volatility.

However, for some funds, volatility has provided a great opportunity to make money.

London-based Caxton Associates, one of the world’s oldest and most popular hedge funds, has been in a position to spike inflation for some time. Unlike some competitors, it has sidestepped sharper deals in favor of more targeted bets on inflation hitting the bond markets. Its global fund is up 7.8 percent and the $2 billion Macro Fund, which is managed by CEO Andrew Low, is up 7.1 percent this year after posting big gains last month, according to a person who has seen the numbers.

Computer-driven funds also flourished. London-based GSA Capital gained about 4.2 per cent last month and New York-based Dynamic Beta Investments made a similar amount in its DBMF, both of which helped with bets against short-term government bonds.

“Our models suggest that short-term interest rate expectations should be higher than what the market was suggesting at the end of September,” said Sushil Wadhwani, former interest rate setter at the Bank of England and head of investment at PGIM Wadhwani. His money profited from bets on short-term bonds and bets on flattening the yield curve.

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Additional reporting by Ortenka Aliaj

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