(Bloomberg) — Hiding in a Hyatt hotel room in the Caribbean, John McClain fired up his laptop Sunday afternoon and began trading bonds. It was supposed to be a family vacation for McClain, but with bank failures mounting and American officials rushing to quell panic, that was now over. He needed to overhaul the $2.4 billion portfolio he managed for clients at Brandywine Global Investment Management LLC, and overhaul it fast.
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In Manhattan, Craig Gorman saw what was coming. He raced to the Park Avenue office of his hedge fund and turned on his computer at 6 p.m. For three straight days, Gorman, a founding partner at Confluence Global Capital, traded almost non-stop, staring at his 11 monitors and munching away. In the blink of an eye that ends abruptly when Ping alerts him to sudden price movements or news.
There have been many wild weeks in the history of finance but few like these in recent memory. As jitters spread quickly from the US to Europe about the health of the banking sector – a concern that barely registered for most investors just days ago – markets were jittery. There were sudden swings in prices for bank shares, corporate debt and commodities but nowhere was the chaos greater than in the $24 trillion market for US Treasuries.
The yield on the two-year note fell more than half a percentage point on Monday, rose more than a quarter point on Tuesday and fell anew on Wednesday as investors re-calibrated how high the Federal Reserve would raise interest rates. The swings, which lasted until Friday, were so violent that they were topped by the collapse of Lehman Brothers, 9/11, the bursting of the dot.com bubble and the emerging-market crises of the 1990s.
Aerobics was done. A select group that included the likes of boutique ETF provider Quadratic Capital Management made quick profits. For many others, there were punitive damages. Quant funds run by Schroder Investment Management Europe SA and AlphaSimplex Group LLC were hit. At Braven Howard Asset Management, some money managers took losses so large that they were ordered to cease trading. It was even worse for veteran macro trader Adam Levinson. He is shutting down his Graticule Asia Macro Hedge Fund after losing over 25%.
It all makes one thing clear: In a market more volatile than post-2008 regulations that curbed trading by Wall Street banks, moments like this have high stakes every minute of every trading day.
“It's crazy,” said Tony Farren, a managing director at Mischler Financial Group in Stamford, Connecticut, who began his career on Wall Street in the 1980s. He said that even a delay of 10 seconds can make or break a business right now. “You can be right and still lose a million dollars.”
trigger
It all began, in many ways, on March 7, the day Fed Chair Jerome Powell signaled to Congress his steely resolve to tighten policy to tame inflation. This cemented expectations of another supersized rate hike and pushed the two-year yield above 5% for the first time since 2007. So when troubles began to emerge in the regional banking sector with Silvergate Capital and then Silicon Valley Bank, many investors were caught off guard. Monday's decline in the two-year yield was the largest since 1982.
As of Wednesday, fresh turmoil at Credit Suisse Group AG triggered another global flight to safety, pushing yields down further. In the short span of a week, the rates market had changed dramatically. Expectations that there would be several more months of Fed hikes, including next week's policy meeting, had vanished. Instead, traders now expect the Fed to cut its benchmark rate by more than a half-point by the end of the year. Things got so chaotic in money-market futures on Wednesday that trading was halted for a while.
outcome
For Priya Mishra, the jitters on Wall Street bear ominous parallels to the dark days of 2008, when she worked as a rates strategist at Lehman. During the week through March 15, banks borrowed $165 billion from the Fed's two backstop facilities to keep their finances safe as panicked depositors pulled cash.
Mishra, global head of rates strategy at TD Securities in New York, canceled a business trip to the West Coast and woke up at 3 a.m. to scan for market moves in Europe and Asia. There also the bonds were swinging wildly.
Mishra said, “All the plans were shelved.” “With every movement in the market or a title, it seems like your blood pressure goes up or down.”
With high volatility, market cracks were exposed, from US dollar funding to underlying Treasuries where the bid-offer spread is spread.
the losers
Like all recent market crises, the quants have emerged — in the eyes of some investors — as the villains of the piece. They say that systematic players like Commodity Trading Advisors inflated volatility by making their big, mistimed bets at higher rates. As Treasuries staged a dramatic rally, the fast-money crowd suddenly had to run for the exits.
The loss was staggering. The Societe Generale CTA index plunged a historic 8% in three sessions through Monday. Losers included AlphaSimplex Group's $2.7 billion managed Futures Strategy Fund. After betting on higher rates last year, it fell 7.2% on Monday alone, the most since early 2010, according to Bloomberg data.
“We were on the wrong side,” said Catherine Kaminsky, chief research strategist and portfolio manager at AlphaSimplex. “This short-bond trade has worked for 15 months. At some point, trends break, and that may be it.
As a group, macro hedge funds declined 4.3% in the week to Wednesday, their worst decline since 2008, according to the HFRX Macro/CTA Index.
Winners
As the markets turned volatile, Nancy Davis, founder of Quadratic, could barely contain her excitement. Its $802 million interest rate volatility and inflation hedged ETF, which invests in inflation-linked bonds and seeks to profit from high volatility, jumped 15% in the week to Wednesday.
“We like 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. He would trade from his room during the day and then, when his daughters had climbed into bed, he would go out onto the balcony at night and trade some more.
Worried about hitting a recession soon, McClain was rushing to protect his portfolio, including the Brandywine Global Corporate Credit Fund, which has outperformed 97% of peers over the past five years in Bloomberg-compiled data.
At Brandywine's headquarters in Philadelphia, McClain's aide, Jack McIntyre, was breathing a sigh of relief. The $30 billion manager had recently placed a bet on long-term Treasuries, which helped protect its funds from the week's moves.
“If we had been short,” McIntyre said, “I would have been a lot more stressed.”
— With assistance from Denitsa Sekova, Emily Grafio, Ruth Carson, Garfield Reynolds, Michael McKenzie, Jessica Menton, and Nishant Kumar.
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