Soaring inflation may scare off investors and consumers, but a group of traders are taking full advantage.
Global macro hedge funds, made famous by George Soros and Louis Bacon, are enjoying their biggest gains in years as inflation unlocks some of their favorite trades in bond and commodity markets.
Macro trading this year is “great,” said a senior executive at one of the world’s largest hedge funds, pointing to the opportunities offered by inflation and bond market moves.
Some managers have “achieved exceptional results in areas such as commodities and directional strategies”. [interest] rates trade in response to changing inflation dynamics,” says Aurum Research.
Market movements this year have been particularly favorable to macro funds that seek strong trends. The yield on interest-rate-sensitive two-year Treasury bonds rose to 3.1% from 0.7% as central banks rush to try to rein in runaway consumer price growth.
Another attractive trade bet on the near-continuous narrowing of the spread between two-year and 10-year US bond yields. The US yield curve is now effectively inverted, with short-term rates moving above longer-term rates. Sharp swings in commodity prices have also been profitable bets for many.
Among the winners is Ray Dalio’s Bridgewater Pure Alpha, which was up 21.5% this year at the end of July, helped by bets that policymakers and markets will eventually react to rising inflationary pressures and tightening markets. monetary conditions. The macro fund managed by Caxton chief executive Andrew Law, which predicted a “great reflation” at the end of 2020, also gained 24.9%, helped by stagflation bets.
Macro funds rose an average of 8.5% in the first half of the year, according to data group HFR. This summer, Kenneth Tropin, founder of $18 billion in assets, Graham Capital, told the Financial Times that he “can’t remember a more exciting time to be a macro investor since the financial crisis”.
Market moves have produced some of the most spectacular returns this year. Crispin Odey, a long lone prophet of high inflation who has suffered a string of losses in recent years, has gained around 115% in his European fund this year. New York-based macro fund Haidar Capital rose around 170%.
The gains stand in stark contrast to the broader hedge fund industry, much of which has a year to forget. Hedge funds are on average down 5.6%, according to HFR, with equity-focused funds particularly hard hit. Many managers found themselves holding too many overvalued tech stocks that were hammered by rising interest rates and offered little hedging to investors.
Unlike many of their equity fund counterparts, macro managers are not dependent on rising markets for their gains. Instead, they look for volatility in bonds, currencies, and other markets.
For much of the last decade, this proved elusive as central bank stimulus suppressed market volatility and crushed their favorite trades. Bets that bond yields would rise from ultra-low levels have often failed.
But last fall marked a turning point. Markets suddenly began to fear that the central bank’s narrative that interest rates would only rise very slowly was ultimately untrustworthy. Some funds, notably Chris Rokos’ Rokos Capital, were caught off guard by the return of bond market volatility.
Some managers are now warning that the market is far too optimistic about the Federal Reserve’s ability to get inflation under control quickly, pointing to the inverted US yield curve as a harbinger of tougher times ahead. Normally, investors seek higher yields to offset the risk of holding bonds longer. An inverted yield curve is a sign that investors expect interest rate hikes to cause an economic slowdown that would eventually lead to an easing of monetary policy.
Decio Nascimento, chief investment officer at hedge fund firm Norbury Partners, which has risen around 7% this year, said market confidence in how quickly US inflation would fall back to 2% is “absurd”. compared to historical precedent.
Odey, meanwhile, expects the market’s “unshakeable belief” that the Fed has done enough to control inflation will be shaken this fall. As markets adjust, he expects big sales in conventional government bonds and big gains in indexed bonds, according to a letter to investors seen by the FT.
If managers like Odey are right, investors and consumers may have to get used to high inflation for some time to come. But for macro funds, the trading opportunities may be just beginning.