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Wednesday, December 1, 2021

Central bank-induced bond turmoil stings big-name hedge funds


The era of unrestricted and generous central banks is coming to an end, which has injected severe volatility into government bonds and caused serious damage to some high-profile hedge funds.

After suddenly rethinking how and when the central bank will reverse the huge wave of support it provided to the market when the pandemic hit last year, the industry’s superstars have already suffered billions of dollars in losses.

Initially, the central bank said that despite the soaring inflation, the process will be very slow, and hedge funds also believed this. But the market began to worry last month that the Fed and other central banks would have to raise interest rates faster, which made prominent traders including Chris Rokos and Crispin Ord stand on the wrong foot.

The violent selling of short-term government debt undermined some of the biggest bets of these funds, causing them to exacerbate market turmoil by quickly exiting positions. Sprinkling salt on the wound later proved that some of the bets were always correct. Repeated blows show that as central bank governors get out of crisis mode, it will still be difficult for the market to negotiate.

Mark Dowding, chief investment officer of bond expert BlueBay Asset Management, said: “There is a little blood on the street.”

For a long time, Mayfair and Wall Street macro hedge fund managers have regretted the trillions of dollars that the central bank has scoured through the market to buy assets, and they say this obscures a major shift they seek to profit from. Judging from the recent series of losses, the industry should have proceeded with caution.

A person who has seen these figures said that London-based Rokos Capital, which manages $12.5 billion in assets, has fallen by about 18% last month. This has caused a fund led by billionaire bond market expert and former Brevan Howard co-founder Rokos to fall more than 26% this year. New York-based Alphadyne Asset Management focused on macro and fixed-income losses, causing it to fall by 17% this year. Since the beginning of October, the performance of the Odey European Fund of Crispin Odey, one of Europe’s most well-known fund managers, has fallen by nearly 50%, although it has risen by around 59% this year.

The culprit is that the bond market turmoil began in late September, when the Bank of England first hinted that it might raise interest rates before the end of the year to curb soaring inflation. This move surprised market participants, who have long believed that this step must be taken and will not be considered until mid-2022. With the help of the hard-line measures of the central banks of Australia and Canada, the spark of the Phnom Penh bond market quickly ignited the hell of the global bond market.

U.S. Two-Year Treasury Bond Yield (%) The line chart shows that the decline in short-term bonds pushes the yield higher

As the Federal Reserve announced on Wednesday that it began to reduce bond purchases, traders began to bet that the world’s most influential central bank would be forced to follow up and raise interest rates early.

In fact, the Fed did announce a gradual reduction of its asset purchase plan, but it is cautious about eventually raising interest rates. The next day, the Bank of England completely refused to raise interest rates, pushing up the price of government bonds and dragging down the yields of government bonds in other countries, which brought a greater impact.

For investors usually regarded as market experts, the restructuring of the bond market proved painful. Tom Prickett, co-head of European interest rate trading at JPMorgan Chase, said: “The tough attitudes adopted by most central banks in response to recent high inflation data and expectations-both obvious and obvious-have made many markets The participants were caught off guard.”

Abandoning bets hastily forced some investors to accept better prices than they might have done under more normal market conditions. Prickett said the gap between dealers’ buying and selling prices—a measure of how easy it is to trade in the market—expanded to typical levels “up to three to four times” in some interest rate markets.

Among other funds that lost money due to volatility, ExodusPoint Capital, which has $13.5 billion in assets, lost about half of its bond risk and lost 2%. In emerging markets that are also feeling the shock, Robert Gibbins (Robert Gibbins) in New York’s Autonomy Capital fell about 7%, this year’s decline reached 28%. The fund was hit by poor bets in the US, Brazil and China bond markets. People familiar with the matter said that London-based Pharo Management’s $5.3 billion Gaia fund and $4.9 billion macro fund fell 2.4% and 2.7%, respectively, which made them fall by more than 10% this year.

Industry insiders said that the reason why the fund failed was because of the way they placed their bets. Some people expect the central bank to increase inflation for a period of time without raising interest rates and directly purchase short-term bonds.

“The central bank’s error is 100%,” said a senior hedge fund trader who avoided confusion. “They didn’t predict inflation, people listened to them.”

Others have made so-called steep curve transactions-betting that long-term yields will rise faster than short-term yields because inflation erodes the value of long-term debt. Odey recently wrote to clients saying that “if the bond market is to reflect inflation,” the 30-year US Treasury bond with a current yield of just under 2% should have a yield of 4.3%.

The line chart of the gap between the two-year and 10-year Treasury bond yields (percentage points) shows that investors’ bets on a steeper yield curve are counterproductive

This type of transaction proved to be disastrous because interest rate hike expectations have gathered so quickly, forcing short-term bond prices lower, pushing up yields and flattening the curve. This flattening indicates that market participants believe that the central bank’s tightening policies may stifle the economic recovery, and even eventually reverse it quickly.

“I think the market is telling you that global central banks are making considerable policy mistakes,” said Gregory Peters, director of multi-sector and strategy at PGIM Fixed Income.

As a sign of these concerns, the price of the 30-year UK government bond that Odey had previously bet on has risen since mid-October, pushing down yields. Some funds have also been hit by erroneously betting that the volatility of the bond market will be lower than that of the stock market.

However, for some funds, volatility provides a good opportunity to make money.

London-based Caxton Associates is one of the world’s oldest and most famous hedge funds, and has been preparing for a rebound in inflation for some time. However, unlike some competitors, it avoided steeper transactions and instead bet more targeted on inflation to hit the bond market. According to a person who has seen the data, its global fund has risen by 7.8%, and its $2 billion macro fund managed by CEO Andrew Law has risen by 7.1% this year after its surge last month. .

Computer-driven funds are also booming. London-based GSA Capital rose about 4.2% last month, and New York-based Dynamic Beta Investments received similar gains in its DBMF funds, both of which benefited from bets on short-term government bonds.

“Our model suggests that short-term interest rate expectations need to be higher than what the market implied at the end of September,” said Sushil Wadhwani, a former interest rate setter at the Bank of England and chief investment officer of PGIM Wadhwani. His fund profited from shorting short-term bonds and betting on a flattening yield curve.

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Additional reporting by Ortenca Aliaj

launce.fletcher@ft.com



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