(Bloomberg) – Hidden in a Hyatt hotel room in the Caribbean, John McClain pulled out his laptop on Sunday afternoon and began trading bonds. This was supposed to be a family vacation for McClain, but as bank failures mounted and US authorities scrambled to contain the panic, that was over. He needed to overhaul the $2.4 billion portfolio he managed for clients at Brandywine Global Investment Management LLC, and fast.
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In Manhattan, Craig Gorman also saw what was to come. He ran to his hedge fund’s Park Avenue office and started his computer at 6 p.m. For three days, Gorman, a founding partner of Confluence Global Capital, traded almost non-stop while eating, staring at his 11 monitors and sneaking into naps that ended abruptly when pings alerted him to sudden price swings or news.
There have been many wild weeks in financial history, but few in recent history quite like this one. As jitters about the health of the banking sector quickly spread from the US to Europe – a concern most investors had barely registered days earlier – markets shook. There were sudden price moves in bank stocks, corporate bonds and commodities, but nowhere was the chaos more acute than in the $24 trillion US Treasury market.
Yields on the two-year note fell more than half a percentage point on Monday, rose more than a quarter point on Tuesday and fell again on Wednesday as investors frantically recalibrated how much more, if any, the Federal Reserve would hike rates . The swings that lasted through Friday were so severe that they outpaced those triggered by the collapse of Lehman Brothers, 9/11, the bursting of the dot.com bubble and the emerging market crises of the 1990s.
Windfalls were made. A select group, which included boutique ETF provider Quadratic Capital Management, made quick gains. There were penalties for many others. Quant funds operated by Schroder Investment Management Europe SA and AlphaSimplex Group LLC have come under pressure. At Brevan Howard Asset Management, some asset managers suffered such losses that they were ordered to halt trading. It was even worse for veteran macro trader Adam Levinson. He is closing his macro hedge fund Graticule Asia after losing more than 25%.
All of this makes one thing crystal clear: in a market made more volatile by post-2008 regulations restricting trading by Wall Street banks, there’s a lot at stake in moments like this, every minute of every trading day.
“It’s crazy,” said Tony Farren, an executive at Mischler Financial Group in Stamford, Connecticut, who began his Wall Street career in the 1980s. Even a 10-second delay can now make or break a trade, he said. “You could be right and still lose a million dollars.”
It all started, in many ways, on March 7th, the day that Fed Chair Jerome Powell signaled to Congress his steely determination to tighten monetary policy to tame inflation. That cemented expectations for another outsized rate hike, pushing two-year yields above 5% for the first time since 2007. So when troubles erupted in the region’s banking sector just days later, with Silvergate Capital and then Silicon Valley Bank, many investors were caught by surprise. Monday’s fall in the two-year yield was the biggest since 1982.
On Wednesday, renewed turmoil at Credit Suisse Group AG sparked another global flight to safety, pushing yields further lower. Within a week, interest rate markets had changed dramatically. Expectations that there would be several more months of interest rate hikes by the Fed, including at a monetary policy meeting next week, had dissipated. Instead, traders are now expecting the Fed’s interest rate to be cut by more than half a point by the end of the year. Money market futures got so chaotic on Wednesday that trading was temporarily halted.
For Priya Misra, the Wall Street tremors had ominous parallels to the dark days of 2008, when she was serving as Lehman’s rates strategist when it went under. In the week ended March 15, banks borrowed $165 billion from the Fed’s two backstop facilities to protect their finances while nervous depositors withdrew cash.
Misra, the global head of rates strategy at TD Securities in New York, canceled a business trip to the West Coast and began getting up at 3 a.m. to scan market movements in Europe and Asia. Bonds were swinging wildly there too.
“All plans went out the window,” Misra said. “Every market move or headline is like your blood pressure going up or down.”
Higher volatility exposed market tears, from US dollar funding to underlying Treasuries where bid-ask spreads widened.
As with all recent market crises, quants have emerged – in the eyes of some investors – as the villains of the play. They say systematic players like Commodity Trading Advisors have exacerbated volatility thanks to their big, ill-timed bets on higher rates. As Treasuries staged a dramatic rally, the crowd of quick bucks suddenly had to rush for the exit.
The losses were staggering. A Societe Generale CTA index fell a historic 8% in three sessions through Monday. Among the losers is AlphaSimplex Group’s $2.7 billion Managed Futures Strategy Fund. After skyrocketing last year on bets on higher interest rates, it fell 7.2% on Monday alone, the most since its debut in 2010, according to Bloomberg data.
“We were on the wrong side,” said Kathryn Kaminski, chief research strategist and portfolio manager at AlphaSimplex. “This short bond trade has been working for 15 months. Eventually, trends break, and that might be the point.”
As a group, macro hedge funds are down 4.3% in the week ended Wednesday, the worst drop since 2008, according to the HFRX Macro/CTA Index.
When the market churned, Quadratic founder Nancy Davis could hardly contain her excitement. Its $802 million interest rate volatility and inflation hedge ETF, which invests in inflation-linked bonds and seeks to profit from higher volatility, is up 15% in the week ended Wednesday.
“We love big moves,” Davis said. “Bring it on.”
Back in the Caribbean, McClain found it impossible to leave the hotel.
He and his family were in Punta Cana, a resort town on the eastern edge of the Dominican Republic. During the day he swapped from his room, and when his daughters climbed into bed he slipped onto the balcony at night and swapped some more.
Concerned about an impending recession, McClain rushed to protect his portfolio, including the BrandywineGlobal Corporate Credit Fund, which has outperformed 97% of its peers over the past five years, according to data compiled by Bloomberg.
Over at Brandywine’s Philadelphia headquarters, McClain’s colleague Jack McIntyre breathed a sigh of relief. The $30 billion manager recently placed a bet on longer-dated government bonds, which helped protect his funds from the week’s moves.
“If we were for just a short duration,” McIntyre said, “I would be a lot more stressed.”
–Featuring Denitsa Tsekova, Emily Graffeo, Ruth Carson, Garfield Reynolds, Michael MacKenzie, Jessica Menton and Nishant Kumar.
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Source : finance.yahoo.com