More pain likely for hedge funds as leveraged investors unwind

There’s likely more pain coming for hedge funds, the heavily leveraged investors which are incurring significant losses from wrong-way positions on the direction of interest rates in the U.S. and across the world, traders say.

Some hedge funds had expected major central banks like the Bank of England and Federal Reserve to turn hawkish on monetary policy given persistent inflation pressures and were caught off guard in the past week by unanticipated dovish pivots, as well as by the flattening of bond-market yield curves. Leveraged players are continuing to unwind their positions, with no let-up in sight, according to traders.

The continued need of hedge funds to short-cover, or buy back securities to close out open short positions, is said to be one of the contributing factors behind Tuesday’s decline in U.S. Treasury yields across the curve. Meanwhile, bond-market yield curves flattened in the U.S., U.K., Germany, Italy, France, and Australia, according to Tradeweb data, resuming a pattern that sometimes points to economic trouble.

“We’re just starting to hear about losses for hedge funds now,” said David Petrosinelli, a senior trader at InspereX in New York. “But the unwinds are starting from a large net-short position, which needs to be covered with purchases of the 10-year Treasury, so I think there is more pain coming.”

ExodusPoint Capital Management and Balyasny Asset Management are two hedge funds that have reportedly nursed losses, according to the Wall Street Journal. Two more are said to be Rokos Capital Management and Alphadyne Asset Management, Bloomberg News reported. Representatives of the firms couldn’t immediately be reached.

Read: Government-bond swings burn Wall Street investors

Tuesday’s fall in yields across the board on Tuesday sent the 10-year BX:TMUBMUSD10Y down to as low as 1.41%, or its lowest level since September, as traders brushed aside data showing U.S. wholesale prices surged in October.

Wednesday brings the U.S. consumer price index report, which is expected to come in toward 6%, or possibly the highest levels in more than 30 years. But more evidence of persistent inflation isn’t likely to deter the current momentum in the market, which has been confounded by the central banks’ dovish policy pivots, traders say.

Last week, the Reserve Bank of Australia, Federal Reserve and Bank of England all “defied market expectations on rate hikes,” said David Gagnon, managing director of U.S. Treasury trading at Academy Securities in San Diego, California. In the U.S., the policy-setting Federal Open Market Committee “threaded the needle with comments that interest rate hikes will depend on COVID-adjusted employment,” and bond investors “were caught off guard.”

Traders were described as still stunned by the Bank of England’s Nov. 4 decision to hold off on a widely expected interest-rate hike, which earned Governor Andrew Bailey the unflattering label of “unreliable…