Interest Rate Time Bomb May Kill Hedge Funds

As March began, hedge funds placed one of their biggest bets of all time. It may be their undoing.

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Traders placed the largest bet in history on increasing short term interest rates. But as a banking crisis spreads, rates may fall, exposing them to huge losses.

From a report out this morning in Reuters:

Hedge funds face huge losses on their record bet that the Fed will go full steam ahead with its aggressive interest rate-raising campaign, after some of the most abrupt and violent swings in U.S. rates and bond market pricing in living memory.

Commodity Futures Trading Commission (CFTC) data shows that speculators held the largest ever net short position in three-month SOFR rate futures in the week ending March 7, only a few weeks after amassing a record short position in two-year Treasuries futures.

Now, their trade is deeply underwater:

Implied rates then plunged as much as 200 basis points in a week as traders drastically redrew their Fed outlook. The two-year Treasury yield posted its biggest fall since the Black Monday crash of 1987, and U.S. bond market volatility surged the most since Lehman’s collapse.

Many funds have already lost 10% of their assets or more so far this month. And as bank after bank fails, the bleeding may get even worse.

A month ago, most of us thought the Federal Reserve would keep raising rates. Inflation was the priority.

Now, with a cascade of bank failures, the Fed may cut rates to stop the crisis. Markets are predicting the Fed will lower rates this summer.

Already, hedge funds are going bust.

Adam Levinson’s Graticule Asia lost 25% this year, most of it in a few days after the SVB collapse. The fund has closed its doors.

As an investor, sometimes I think I know where markets are heading. But I never put too many eggs in one basket.

I’m playing with my own money. But most hedge funds aren’t.

And it’s not hard to tell.

What do you think will happen to these funds?

Leave a comment and let me know!

More on markets:

Executives Dumped Shares Shortly Before First Republic Rescue

SVB Fallout

Goldman Sachs Under Federal Investigation

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