Holed up in a Hyatt hotel room in the Caribbean, John McClain whipped out his laptop on Sunday afternoon and started trading bonds. This was supposed to be a family vacation for McClain but, with bank failures piling up and US authorities rushing to stem the panic, that was out now. He needed to overhaul the $2.4 billion portfolio he managed for clients at Brandywine Global Investment Management and overhaul it fast.
(Bloomberg) — Holed up in a Hyatt hotel room in the Caribbean, John McClain whipped out his laptop on Sunday afternoon and started trading bonds. This was supposed to be a family vacation for McClain but, with bank failures piling up and US authorities rushing to stem the panic, that was out now. He needed to overhaul the $2.4 billion portfolio he managed for clients at Brandywine Global Investment Management and overhaul it fast.
In Manhattan, Craig Gorman saw what was coming, too. He raced over to his hedge fund’s Park Avenue office and fired up his computer at 6 p.m. For three straight days, Gorman, a founding partner at Confluence Global Capital, would trade nearly non-stop, eating as he stared at his 11 monitors and sneaking in naps that would end abruptly when pings alerted him to sudden price swings or news.
There have been many wild weeks in the history of finance but few in recent memory quite like this one. As jitters rapidly spread about the health of the banking sector from the US to Europe — a concern that had barely registered for most investors just days earlier — markets shook. There were sudden moves in prices for bank stocks, corporate debt and commodities but nowhere was the chaos more acute than in the $24 trillion market for US Treasuries.
Yields on the two-year note sank more than half a percentage point Monday, soared over a quarter-point Tuesday and tumbled anew on Wednesday as investors frantically re-calibrated how much more, if at all, the Federal Reserve would raise interest rates. The swings were so violent — right through the close of trading on Friday — they topped those triggered by the collapse of Lehman Brothers, 9/11, the bursting of the dot.com bubble and emerging-market crises of the 1990s.
Windfalls were made. A select group that included the likes of boutique ETF provider Quadratic Capital Management racked up quick profits. For others, there were punishing losses. Quant funds run by Schroder Investment Management Europe SA and AlphaSimplex Group LLC got hammered. At Brevan Howard Asset Management, some money managers took such big losses they were ordered to stop trading. And for veteran trader Adam Levinson, the news was even worse. He’s shuttering his Graticule Asia macro hedge fund after it lost more than 25%.
All of which makes one thing crystal clear: In a market made more volatile by post-2008 regulations that curbed trading by Wall Street banks, the stakes are high every minute of every trading day at moments like this.
“It’s nuts,” said Tony Farren, a managing director at Mischler Financial Group in Stamford, Connecticut, who began his career on Wall Street in the 1980s. Even a 10-second delay can make or break a trade right now, he said. “You could be right and still lose a million dollars.”
The Trigger
It all started, in many ways, on March 7, the day Fed Chair Jerome Powell signaled to Congress his steely resolve to ramp up policy tightening to tame inflation. That cemented expectations for another supersized rate hike and pushed two-year yields above 5% for the first time since 2007. So when the troubles in the regional banking sector began to emerge just days later, first with Silvergate Capital and then Silicon Valley Bank, many investors were caught badly off-guard. Monday’s plunge in the two-year yield was the biggest since 1982.
By Wednesday, fresh turmoil at Credit Suisse Group AG set off another global flight to safety, driving yields down further. In the short span of a week, rates markets had shifted dramatically. Expectations there’d be several more months of Fed hikes, including at a policy meeting next week, had vanished. Instead, traders now expect more than half a point of cuts to the Fed’s benchmark rate by year-end. Things got so chaotic in money-market futures on Wednesday that trading was briefly halted.
The Fallout
To Priya Misra, the tremors on Wall Street bore ominous parallels to the dark days of 2008 when she served as a rate strategist at Lehman as it went under. In the week through March 15, banks borrowed $165 billion from the Fed’s two backstop facilities to safeguard their finances as jittery depositors yanked cash.
Misra, the global head of rates strategy at TD Securities in New York, canceled a business trip to the West Coast and started waking up at 3 a.m. to scan market moves in Europe and Asia. Bonds were swinging wildly there, too.
“All the plans went out the window,” said Misra. “With every movement in the market or headline, it’s like your blood pressure goes up or down.”
With higher volatility, market cracks were exposed, from US dollar funding to underlying Treasuries where bid-offer spreads widened. Oddly, stocks were largely exempt from the mayhem. The S&P 500 grinded higher on the week.
The Losers
Like all recent market crises, quants have emerged — in the eyes of some — as the villains of the piece. These critics say systematic players like Commodity Trading Advisors exacerbated the volatility thanks to their big, ill-timed bets on higher rates. As Treasuries staged a dramatic rally, the fast-money crowd had to rush for the exit all of sudden.
The losses were staggering. A Societe Generale CTA Index dropped an historic 8% over three sessions through Monday. The losers include AlphaSimplex Group’s $2.7 billion Managed Futures Strategy Fund. After soaring last year by betting on higher rates, it tumbled 7.2% on Monday alone per Bloomberg data, the most since its 2010 debut.
“We were on the wrong side,” said Kathryn Kaminski, chief research strategist and portfolio manager at AlphaSimplex. “This short-bond trade has worked for 15 months. At some point, trends break, and this could be the point.”
As a group, macro hedge funds lost 4.3% in the week through Wednesday, the worst drop since 2008, according to the HFRX Macro/CTA Index.
The Winners
As the market went haywire, Nancy Davis, founder of Quadratic, could scarcely hide her excitement. Her $802 million Interest Rate Volatility and Inflation Hedge ETF, which invests in inflation-linked bonds and seeks to profit from higher volatility, jumped 15% in the week through Wednesday.
“We love big moves,” said Davis. “Bring it on.”
Back in the Caribbean, McClain was finding it impossible to leave the hotel.
He and his family were in Punta Cana, a resort town on the Dominican Republic’s eastern edge. He’d trade from his room during the day and then, when his daughters would climb into bed at night, he’d slip out onto the balcony and trade some more.
Worried a recession may land soon, McClain was rushing to protect his portfolio, including the BrandywineGlobal Corporate Credit Fund, which has bested 97% of peers over the past five years in Bloomberg-compiled data.
Over at Brandywine’s headquarters in Philadelphia, McClain’s colleague, Jack McIntyre, was breathing a sigh of relief. The $30 billion manager had recently placed a bet on longer-term Treasuries, which helped safeguard his funds from the week’s moves.
“If we were short duration,” McIntyre said, “I’d be a lot more stressed out.”
–With assistance from Michael MacKenzie, Jessica Menton, Nishant Kumar, Denitsa Tsekova, Emily Graffeo, Ruth Carson and Garfield Reynolds.
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