Reflation trading is mistakenly developing several big name hedge funds


Investors are reevaluating their belief in the thinking business that captivated Wall Street this year after the falcon inclination from the central bank of the United States inflicts losses on some fund managers.

The bet against the price of U.S. government bonds was a winning piece earlier this year, with hedge funds and other investors racking up significant gains as the economic recovery picked up pace. But recent turns and the specter of a policy pivot by the Federal Reserve have cast significant doubt on whether investors should stay in the trade.

“It is clear that the inflation trade has been shaken,” said Thanos Bardas, deputy director of fixed income investments at Neuberger Berman. “The market has reacted too much, [but] uncertainty has increased ”.

Several big-name hedge funds have been stuck in the turmoil, including Andrew Law’s Caxton Associates and Chris Rokos’s Rokos Capital.

The rationale for the inflation trade was centered around the expectation that the acceleration of the U.S. vaccination program and the removal of Covid-19 blockade measures would introduce a period of high growth and inflation when activity business began to normalize.

The Fed’s insistence that it also seemed to pass on rapidly rising U.S. consumer prices, which it considered temporary, before adjusting to its ultra-accommodative monetary policy, further encouraged investors to take a counter position. to the more dated Treasuries. Long-term debt tends to suffer disproportionately from inflation as it erodes value to investors of interest payments that are “fixed” for a period that extends over several years.

Hedge funds piled up in the trade, betting that it was the next big win after profiting from the price meeting for U.S. treasuries last year. Caxton, one of the best-performing expense funds in 2020, wrote in December that “the stadium may be well prepared for great reflection.” Some funds bet on bonds, while others put positions against the dollar.

The last few months have taken the splendor of this trade, with renewed purchases in the 10-year Treasury sending yields that fall well short of the last highs recorded in March 2021 despite larger jumps than expected in consumer prices. But it was the June meeting of U.S. central bankers and emerging signals that the Fed may not be tolerant of higher inflation as predicted in the new policy framework it unveiled last August that gave the hit the most significant to date.

After initially selling sharply after the meeting – which opened the door to two interest rate hikes in 2023 – U.S. government bond prices are higher as investors struggled with how to decipher the slightly less dovish tone from the Fed. This price increase pushed the 10-year benchmark yield up 1.35 percent this month, from highs of nearly 1.8 percent in March. Since then it has been stable at about 1.50 percent.

The two-year note, which is more sensitive to monetary policy adjustments, has changed higher, with yields of 0.11 percentage points since the beginning of the month to 0.26 percent. This has led to a rapid flattening of the yield curve, which traces the difference between long-term and short-term Treasury yields.


“What has happened has been a bit of a reinterpretation of what the Fed is doing [framework] it really means, “said Michael De Pass, global leader of the U.S. government’s bond trade in the Citadel.” The narrative “lets it run” is perhaps not as pronounced as market participants anticipated. “

The line chart of 2-year government notes (%) showing the Fed’s policy change signal pushes short-term yields higher

He added: “Confidence in the [reflation trade] she was drunk. “

Price fluctuations have been partly amplified by how funds have been placed in the direction of the Fed meeting. And so-called “steepener” bets that profit when longer-term Treasury prices decline at a faster rate than shorter-date notes were particularly crowded ahead of the Fed meeting, according to CFTC data.

Caxton has suffered a drop of about 8 percent in its $ 2 billion Macro fund, which is still on the rise this year, say people who had seen the numbers.

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

While some executives have been bruised by the reversal of the reflective trade, others are holding firm, using the recent “position washing” – as one trader said – as a buying opportunity.

“Nothing in our view has changed. We’re all in the inflation business,” said Bob Michele, chief investment officer at JPMorgan Asset Management, who said his team has added to its strong stakes in recent years. days. “We think there is a lot of growth and inflationary pressures that are developing in the economy… [and] we are only halfway through the reopening at home. “

Dan Ivascyn, the group’s chief investment officer at Pimco, is also of the view that long-term Treasury yields are likely to grow from there, as the risk of inflation is “at an advantage”. But he warned that the road ahead could be disastrous.

“You’re in a period where assessments are much longer,[and]it takes less bad news to create the same amount of volatility, “Ivascyn said.” You want to keep controlling your thinking. “

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