Few will shed a tear for the travails of the Mayfair set, and nor should they. Of late, many macro hedge fund managers who seek to make money out of big economic and monetary shifts have had what can politely be described as a complete nightmare.
To the immense amusement of online meme creators, some of the most prestigious funds in the business bet big on the global interest rate outlook and lost, bigly. Adding insult to injury, the damage stemmed largely from rinky-dink UK government bonds — a crucial pillar of the British financial system but not exactly the glamorous end of the global debt market.
The episode is studded with exasperated traders, multibillion-dollar losses, and frustration that the Bank of England should have the audacity to torpedo Very Serious Bond Bets. If anyone is going to do that, it should be the Fed, surely? The European Central Bank at a push. (As one US investor put it to us this week: “No offence to our British friends . . . But dude, you don’t matter that much. Why are you driving our market?”)
Behind the punctured egos and schadenfreude, however, lies a serious message for investors of all types. In short, it is wise to buckle up.
First, a quick recap on what went wrong. One element is that betting on a turn in the global interest rate environment is hugely popular, and investors often pick hedge funds to do this heavy lifting for them. “Clients are more interested in hedge funds than they have been for four years,” says Peter van Dooijeweert, managing director at Man Solutions at Man Group.
These funds do not really exist to take staid, boring positions. Instead, investors want them to be bold, and they are. “Clients want the volatility,” says van Dooijeweert. “You are hiring them to make you 40 per cent. That means they will have rainy days. Ideally not a deluge that floods the basement, but rainy days.”
The Kremlinology of picking meaning out of central bankers’ statements is a key way for funds to do this — a highly specialised sport of reading between the lines.
Alan Greenspan, chair of the Federal Reserve from 1987 to 2006, was sphinx-like in his comments. As he once famously remarked: “I know you think you understand what you thought I said but I’m not sure you realise that what you heard is not what I meant.”
Jean-Claude Trichet, president of the ECB from 2003 to 2011, operated a system of policy-by-code word. Euro traders and others judged the likelihood of interest rate rises on whether he said inflation warranted “vigilance”, “strong vigilance” or, if he was really worried, “very strong vigilance”.
Some central bankers are better at “speaking markets” than others. Mario Draghi, ECB president through the business end of the Greek debt crisis was il maestro of this art, nudging the euro or European government bond yields higher or lower as desired with knowing references to arcane financial indicators.
Traders felt they knew and trusted him, so when he declared in the summer of 2012 that the ECB would do “whatever it takes” to preserve the euro, they knew he meant it. No details required; just those three little words were enough to put the region’s entire bond market on a steadier footing.
His successor, Christine Lagarde, discovered the hard way that slip-ups can be costly. In one of her first press conferences in the top job, she suggested it was not the ECB’s job to keep the bond market in check. Cue an ugly slide in Italian government bonds, and a rapid apology.
That brings us to Andrew Bailey, governor of the BoE, grappling with the undoubtedly tricky task of seeking to explain what the central bank might, or might not do, in response to a global surge in inflation. Bailey had already signalled rising unease with inflation but in mid-October, he stepped up the tone, saying “we will have to act”.
Sure, there were caveats, ifs and buts, and hints are not promises. Still, this threw gilts in to a bet on imminent rate rises, putting wagers on greater patience through the woodchipper. The punchline: the BoE ended up holding fire in its rate-setting meeting just days later.
This matters beyond the quilted-jackets-and-boat-shoes crowd of hedge fund land for several reasons. One is that the shockwaves that emanated from the gilts market (and arguably also from Australian government bonds) in to Treasuries and Bunds offer a reminder on how interconnected the financial system is.
Another is that while central bankers often say they are not there to help hedge funds make money, market participants often do not believe them. This demonstrates they should.
Very clearly, the overall financial system coped just fine. Policymakers are not trying to shake up markets just for giggles, but as long as financial stability is not compromised, it is not really their problem. This could prove an important point as central banks gradually withdraw their support — a process almost guaranteed to inject volatility. Investors who truly believe policymakers would quickly step in to stop any markets rot might want to think again.
katie.martin@ft.com
November 12, 2021 at 12:00PM
https://www.ft.com/content/01f0d940-9a59-4085-91cc-f9bdc6fd07ec
Hedge funds learn the hard way in bonds shock - Financial Times
https://news.google.com/search?q=hard&hl=en-US&gl=US&ceid=US:en
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