The trade of reflection disconnects the wrong feet from several well-known hedge funds

Investors are reassessing their conviction in the reflation trade that has captivated Wall Street this year after a sickle tilt by the US central bank caused losses to some fund managers.

Betting on the price of U.S. government bonds was a winning work earlier this year, as hedge funds and other investors made significant gains as the economic recovery picked up pace. But recent riots and the specter of a Federal Reserve federal policy pivot have raised significant doubts about whether investors should remain in the trade.

“It’s obvious that the reflation trade was rinsed out,” said Thanos Bardas, Neuberger Berman’s deputy director of fixed income investments. “The market reacted too much, [but] uncertainty has increased “.

Several big-name hedge funds were trapped in the maelstrom, including Andrew Law’s Caxton Associates and Chris Rokos ’Rokos Capital.

The justification for the reflation trade has centered around expectations that the acceleration of the U.S. vaccination program and the elimination of Covid-19 closure measures would introduce a period of high growth and inflation to as business activity began to normalize.

The Fed’s insistence that it would also look beyond the rapid U.S. consumer prices, which it considered temporary, before adjusting its ultra-accommodative monetary policy, further encouraged investors to take a stand against the older Treasuries. Long-term debt tends to suffer disproportionately from inflation, as it erodes the value for investors of “fixed” interest payments over a period of many years.

Hedging funds rallied in the trade, betting it was the next big win after last year they benefited from rising U.S. Treasury prices. Caxton, one of the best-performing hedge funds in 2020, wrote in December that “the stage can be set for great reflection.” Some funds bet on bonds, while others bet on positions against the dollar.

The last few months have taken the to shine of this trade, with the renewal of the ten-year treasury purchase that generated returns that fell from the recent highs recorded in March 2021 despite the higher-than-expected jumps in consumer prices. But it was the June meeting of US central bankers and the incipient signs that the Fed may not be as tolerant of higher inflation as previously expected under the new policy framework it introduced last August that gave the most important blow so far.

After selling sharply after the meeting (which opened the door to two interest rate hikes in 2023), U.S. government bond prices rose as investors struggled with how to decipher the slightly less dovel tone of the Fed. This rise in price pushed the 10-year benchmark yield to 1.35% this month, from a high of almost 1.8% in March. It has since remained at around 1.50 per cent.

The two-year note, which is more sensitive to monetary policy adjustments, rose, with a yield of 0.11 percentage points from the beginning of the month to 0.26%. This led to a rapid flattening of the yield curve, which tracks the difference between long-term and short-term Treasury yields.

“What happened was a bit of a reinterpretation of what the Fed was doing [framework] it really means, “said Michael De Pass, world head of U.S. government bond trading at the Citadel.” The narrative “leave it hot” may not be as pronounced as market participants anticipated. “

He added: “Confidence in the [reflation trade] has been dented “.

Price changes were widened in part by the positioning of funds toward the Fed meeting. According to CFTC data, so-called “louder” bets benefit when Treasury prices with a longer date fall at a faster rate than notes with shorter dates.

Caxton suffered a roughly 8% drop in its $ 2 billion Macro fund, which is still rising this year, according to people who had seen the figures.

Brevan Howard has lost about 1.5% in its main fund in June and 2.9% in a fund managed by trader Alfredo Saitta. Rokos has lost about 4% this month, according to people who know its performance. Rokos and Brevan declined to comment, while Caxton did not respond to any requests for comment.

While some managers have been burned by the reversal trade investment, others remain steadfast, using the recent “positioning wash” – as one trader put it – as a buying opportunity.

“Nothing in our opinion has changed. We’re all in the trade of reflation, ”said Bob Michele, chief investment officer of JPMorgan Asset Management, who noted that his team has added to its strong bets in recent days. great growth and inflationary pressures that are accumulating in the economy … [and] we are only in the middle of the national reopening ”.

Dan Ivascyn, the group’s chief investment officer at Pimco, also believes long-term Treasury yields are likely to increase from here, as the risk of inflation is “on the rise”. But he warned that the way forward could be bumpy.

“We are in a period in which valuations are much more stretched,[and]it takes less bad news to create the same amount of volatility, “Ivascyn said.” You want to keep checking your thinking. “

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