Hedge Funds have Started to Bet End of Good Times

U.S. Treasury market, 10-year yields have almost doubled since the start of the year to reach 1.6%, triple the low reached in August last year. U.K. yields have quadrupled to 0.8% since January, while German yields are at -0.2%, up from -0.6%.

With that, hedge funds have started to bet that the good times may be about to come to a crashing end. Investors are currently running short positions on $55 billion of global high-yield debt, up from $35 billion at the beginning of the year, according to IHS Markit Ltd. data cited by my Bloomberg News colleagues Laura Benitez and Tasos Vossos. That’s the industry’s biggest collective bet against junk bonds since 2008.

Hedge funds have currently borrowed some $30 billion of European investment-grade debt to sell in anticipation of profiting from declining prices. That’s helped push almost half of the region’s new 2021 bonds sold by non-financial companies with ratings higher than junk below their initial selling prices.

What it meant here is that, those that believe that bond price would trend lower might end well as there is a high probability that it is likely to trend up.

In December 2000, with the 10-year Treasury yielding about 3.3%, buying U.S. government debt was deemed “a suicidal investment” by Marc Faber, publisher of the Gloom, Boom and Doom report. A Bloomberg News survey of Wall Street’s 18 biggest bond-trading firms showed a consensus forecast for the yield to climb to 3.65% in the following year.

That didn’t happen. Instead, the Treasury yield spent most of the next six months between 3% and 3.5%, before dropping to finish 2011 at a bit less than 2%. It averaged 1.8% in 2012 and 2.3% in 2013, although by the end of that year it was back up to 3%. In the decade through the end of 2020, its average level was about 2.2% — and it ended the pandemic-plagued year at 1%.

When taper tantrum happened in May 2013, treasuries lost $1.5 trillion of value in a fortnight after then Federal Reserve Chairman Ben Bernanke first suggested the U.S. bond-purchase program would be scaled back. The benchmark yield soared by half a percentage point to end the month at 2.13%. Even a short-lasting spike in yields can ruin the year for a wrongly positioned hedge fund.

This time around, there’s a concern that the ultra-low yields on even the riskiest debt — global junk-rated debt offers about 4.3%, its lowest ever — make the fixed-income market more exposed than ever to any hint that central banks are preparing to scale back their support.

Reference

Bloomberg, 2021-05-12, “Hedge Funds Are Guarding Against a Bond Tantrum”