Macroscope
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Hedge funds cheer the return of volatile markets

Ever since Donald Trump emerged as the outlier president-elect, macro hedge funds suddenly have several compelling themes to latch on to

PUBLISHED : Thursday, 22 December, 2016, 12:49pm
UPDATED : Thursday, 22 December, 2016, 12:49pm

Global macro hedge fund managers, who take big bets on political and economic changes in countries and often thrive during periods of financial volatility, have a spring in their step as 2016 draws to a close.

After years in which the ultra-loose monetary policies of the world’s main central banks suppressed volatility and distorted asset prices, wrong-footing (and even forcing the closure of) many macro funds, the prospect of a decisive shift towards reflationary economic policies following the upset victory of Donald Trump in last month’s US presidential election is fuelling speculation that markets have reached a pivotal inflection point.

For investors who specialise in identifying and exploiting key trends in markets, macro hedge funds suddenly have several compelling themes to latch on to.

One of the most important ones is the prospect of a “great rotation” out of bonds and into equities. In the month following the US election, a staggering US$2 trillion was wiped off the value of the Bloomberg Barclays Global Aggregate bond index (the worst month for global debt in dollar terms on record), roughly the same amount that was ploughed into global stock markets, according to data from Bloomberg.

On Wednesday, the Dow Jones Industrial Average, one of the main US equity indices, was closing in on the 20,000-point level for the first time.

Another key trend is growing divergence in monetary policies.

Amid all the talk of a sharp sell-off in debt markets - and potentially a full-blown bond bear market - as the Federal Reserve signals a faster-than-anticipated pace of interest rate hikes next year, bond yields in Europe and Japan, particularly at the shorter end of the curve, remain at exceptionally low levels.

On Monday, the yield on 2-year German Bunds fell to a fresh record low of minus 0.82 per cent in response to a recent decision by the European Central Bank (ECB) to adjust its bond-buying programme to include debt yielding less than minus 0.4 per cent, the current level of the ECB’s deposit rate, thereby significantly widening the eligibility criteria for the central bank’s quantitative easing (QE) programme.

This has contributed to a sharp increase in the gap between the yields on German and US debt.

While the yield on benchmark 10-year US Treasury bonds has increased to 2.5 per cent, its German equivalent, although no longer in negative territory, stands at a mere 0.2 per cent, the widest gap since 1989, according to Reuters. Japanese government bond yields also remain at exceptionally low levels despite the sell-off in US Treasuries, with the country’s 10-year yield barely above zero.

This divergence in interest rates has, not surprisingly, ricocheted into the foreign exchange markets. The dollar index, a gauge of the greenback against a basket of its peers, has shot up 5.7 per cent since Trump’s victory to its highest level in 14 years. The surge in the dollar has pushed down the yen to its weakest level against the greenback since early February, turning the dollar-yen exchange rate into the most favoured currency pair for bets on Trump’s economic policies.

There has also been a polarisation in the currency markets of developing economies since the US election.

While the Mexican peso and the Turkish lira have both plunged more than 11 per cent against the dollar, the Chilean peso and the Russian rouble have gained almost 4 per cent and 4.5 per cent respectively. While country-specific factors are at play, the recovery in commodity prices has buoyed, or at least offset some of the post-election weakness of, a number of emerging market currencies.

A stronger dollar, however, could cause a relapse in commodity markets (a crucial determinant of sentiment towards emerging markets), showing the extent to which emerging market macro trades now hinge on fund managers’ ability to foresee the impact of Trump’s reflationary policies.

Another key trend which macro hedge funds can latch on is politics.

market reaction to the escalation in political risk in 2016 has varied significantly depending on the country and the perceived effect on the policy environment, providing fund managers with vital ammunition for their 2017 trades.

While sterling has plunged 17 per cent against the dollar since the Brexit vote, Italian bond yields remain at exceptionally low levels despite the country’s political and banking woes. Meanwhile, the election of a demagogue as US president has sent equity markets soaring.

Louis Bacon, the founder of Moore Capital, one of the largest macro hedge funds, says Trump’s victory has “launched nothing short of a sea change in the potential opportunity for trading markets globally.”

Hardly surprising, then, that macro traders are in an upbeat mood.

Nicholas Spiro is partner of Lauressa Advisory

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