COLUMN-Hedge funds’ FX plays get crushed in red October: McGeever

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(Opinions expressed here are those of a columnist writer for Businesshala)

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ORLANDO, Fla., Nov 10 (Businesshala) – The recent explosion in interest rate volatility and a dramatic reassessment of central banks’ near-term policy trajectory has claimed few victims across the financial market spectrum, more than currency-trading hedge funds. Nothing .

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Policymakers from Brazil to the UK and from Turkey to Canada have cautioned investors with surprising rate decisions and policy guidance. Yet it is leveraged foreign exchange trading, where interest rate differential speculators run currency bets, that spillover is most visible.

Hedge fund industry data provider HFR’s benchmark currency index fell 4.37% in October to a four-and-a-half-year low, its biggest monthly decline since the index’s inception in 2008.

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Of the HFR’s close to 40 major benchmark indices across a range of asset classes and strategies, it is the only one so far in the red.

As HFR President Ken Heinz points out, every FX trading style and strategy lost money in October – carry, momentum, price and volatility – while the flat US yield curve also tightened the squeeze on funding for FX carry strategies. Gave.

However, given the calm atmosphere in most currencies, the massive total loss in October is puzzling, with implied volatility and spot exchange rates barely rallying.

Morgan Stanley analysts compare the equity and currency markets to duck swimming — gliding calmly across the water, but paddling furiously beneath the surface. Frenzied churns are wild swings in short-term rates.

They found that apart from the volatility at the start of the COVID-19 pandemic in February-April 2020, the past few weeks have produced the highest intensity of large one-day cross-asset moves at any time since 2011.

Don’t hedge funds crave volatility to pounce on price mismatches and arbitrage opportunities? If they can ride the rising tide of volatility, it is considered ‘good’ volatility; But if the wave crashes over them, that’s ‘bad’ volatility.

“Traders always want to look for relative value and disconnects, but what we have seen in the rate space is that a lot of these relationships have been unusually awkward. It reduces risk appetite,” says Morgan Stanley. Chief cross-asset strategist says Andrew Sheets.

These asymmetries include flattening at the ultra-short end of some rate curves, and flattening – even inverse – at the ultra-long end of others. These moves can disrupt funds betting on long-term trends while simultaneously taking advantage of short-term anomalies.

policy deviation

In normal times, investors are prone to more uncertainty around the long-term outlook than the near-term horizon. This goes for almost everything, from central bank policy and inflation to growth and political risk.

It helps explain the risk premium and term premium in the bond markets, and why yield curves should be trending upward.

But these are not normal times. There is no playbook for how policymakers navigate the economy out of the global pandemic, and no blueprint for investors to navigate the lack of clarity.

Some of the world’s best-known macro hedge funds have suffered huge losses due to a recent burst of central bank ‘miscommunication’ and the subsequent dramatic re-pricing of rate expectations.

After the Reserve Bank of Australia abruptly decided not to intervene in the bond market and cap three-year yields at 0.1%, the Bank of Canada briefly ended its quantitative easing bond-buying program, indicating that That it was preparing to raise rates, the Bank of England backed away from pulling the trigger.

Many emerging market central banks put their foot on tighter accelerators – especially Brazil’s – prompting mixed and unpredictable currency swings. Meanwhile, Turkey’s central bank cut rates by 200 basis points.

Perhaps most alarming is the growing uncertainty around the makeup and direction of the Federal Reserve. Chair Jerome Powell’s re-nomination is far from guaranteed, and three resignations have freed up seats on the institute’s ratings committee.

Last week volatility in the US Treasury market rose to its highest level since March last year, while key gauges of US dollar volume against major currencies and the VIX index, which measures the volatility of the S&P 500, remained anchored near recent lows. Huh.

According to JPMorgan’s FX strategy team, interest rate volatility, if not FX volume, is likely to remain a major driver for currency markets for the rest of the year.

“The markets are left with very weak confidence in the central bank’s forward guidance, a greater willingness to reevaluate on the data surprise and thus a tendency to test the limits of central bank patience,” he wrote in a note on Friday. “

by Jamie McGyver; Editing by Jacqueline Wong

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