Original Title: The Fed Releases “Interest Rate Increase + Balance Sheet Reduction” Blockbuster Hedge Funds Urgently Adjust Positions to Face Turbulent Times
“The Fed does not speak, it is a blockbuster.” A Wall Street hedge fund manager sighed to reporters.
On January 6, the Fed’s latest December 2021 monetary policy meeting minutes announced once again dropped a blockbuster in the global financial markets. Fed officials at the meeting believed that it might be appropriate to start reducing the size of the Fed’s balance sheet in a relatively short period of time after it started raising the federal funds rate.
“This means that the Wall Street financial market has not yet digested the Fed’s early interest rate hike expectations, and was caught off guard by the Fed’s early reduction of its balance sheet.” The above-mentioned hedge fund manager pointed out.
Affected by this, the global financial market ushered in a round of violent turbulence on January 6. The Nasdaq index plummeted by more than 3.3%, the largest one-day decline since February last year; the yield of 10-year U.S. Treasury rose in one fell swoop and exceeded 1.7 % (That is, bond prices plummeted), hitting the highest value since April 2020; gold spot prices fell below $1,790 per ounce, setting a new low since December 29 last year.
“As soon as the news came out, Wall Street investment institutions began to realize that they must prepare for the Fed to simultaneously raise interest rates and shrink balance sheets in terms of asset allocation in 2022.” A director of the asset allocation department of a large Wall Street asset management institution pointed out to reporters.
The reporter learned that the 60/40 equity bond allocation strategy that had previously been popular on Wall Street was facing a huge performance test.
Many Wall Street hedge fund managers stated that they are considering abandoning the 60/40 equity bond allocation strategy, because the Fed’s early interest rate hike and balance sheet reduction will trigger the “equity bond double kill”. May encounter a larger net worth retracement.
“At present, we are trying to transfer 20% of funds to cross-cycle alternative investments, including equity investment and real estate trust Reits investment, and increase cross-cycle investments to avoid the turbulence caused by the Fed’s shrinking balance sheet.” The aforementioned Wall Street hedge fund manager told reporters.
“Since the Fed discussed the advance of shrinking the balance sheet, we have been in a financial market with sudden increase in uncertainty. If we are not careful, we may face investment returns in vain.” A large European asset management agency’s chief representative of the Asia-Pacific region told reporters, Global Asset Management Institutions are looking for ways to diversify investment and diversify asset allocation to get rid of the impact of financial market turmoil.
Wall Street “shocked”
“On January 6, the entire Wall Street was discussing when the Fed will shrink its balance sheet.” said the aforementioned Wall Street hedge fund manager. Obviously, the Fed’s discussion of shrinking the balance sheet at the December monetary policy meeting greatly exceeded the expectations of the financial markets.
Originally, financial institutions generally expected the Fed to follow the Bank of England’s approach, raising interest rates without shrinking the balance sheet, and then releasing sufficient liquidity to the financial market to promote economic growth. However, rising inflationary pressures may force Fed officials to put “balance sheet reduction” on the agenda.
The latest trend of US federal funds rate futures shows that after the release of the minutes of the Federal Reserve’s December monetary policy meeting, traders believe that the probability that the Fed will raise interest rates by 25 basis points in the March policy meeting is as high as about 80%, because the Fed gave a specific “reduction”. Before the timetable, it is bound to accelerate the pace of interest rate hikes.
This triggered a “double kill” scenario in the US financial market in the early hours of January 6. Not only did the Nasdaq index plummet by more than 3.3%, the 10-year fall in U.S. bond prices caused its yield to exceed 1.7% at one point.
At the same time, the US financial market fear indicator-Cboe Volatility Index VIX hit the highest level since December 21 last year.
“It’s been a long time since I saw such a big panic in Wall Street financial institutions.” The aforementioned Wall Street hedge fund manager said bluntly. The Fed caught the market by surprise, and investment institutions have also begun to realize that the volatility of the US financial market in 2022 may greatly exceed expectations. Looking at the volatility of financial markets in the past decade or so, as long as the Fed pulls the trigger to shrink the balance sheet, the U.S. stock market will often show greater turbulence.
Bob Miller, Head of Fundamentals and Fixed Income at BlackRock in the United States, said frankly that Wall Street investment institutions now believe that the Fed’s reduction of its balance sheet is no longer a question of “whether to proceed”, but a question of “when it will land”.
UBS predicts that the Fed may decide on the specific operating time of the balance sheet reduction in May-June after ending its QE bond purchase operation in March.
UBS also pointed out that the Fed’s pace of shrinking the balance sheet may be gradual, reducing US$10 billion in Treasury bonds and US$5 billion in MBS quarterly from 2022 to 2023; from 2024 onwards, it may reduce US$40 billion in Treasury bonds and US$20 billion each quarter. MBS: Eventually, by the end of 2025, the Fed’s balance sheet may shrink by about 2 trillion US dollars.
“This means that the Federal Reserve will withdraw approximately US$2 trillion from the financial market in the next three years. If we consider that investment institutions use QE funds to carry out leveraged investments, we expect the liquidity of the US financial market to shrink by more than US$6 trillion. The valuation of many assets in the financial market will undergo drastic revaluation.” The aforementioned director of the asset allocation department of a large Wall Street asset management institution pointed out.
Traditional equity and debt allocation strategy “falls out of favor”
Facing the Fed’s advance interest rate hike and balance sheet reduction, Wall Street investment institutions were shocked and quickly adopted precautionary measures.
The reporter learned that some Wall Street hedge funds began to discuss whether the traditional 60/40 equity bond allocation strategy is still effective. They worry that the Fed’s shrinking balance sheet will result in a “double kill of stocks and debts,” and this asset allocation strategy may aggravate the decline in net worth.
“Currently, hedge funds that adopt a 70/30 equity bond allocation strategy are facing greater pressure to adjust their positions.” Hedge fund MKS PAMP analyst Sam Laughlin said bluntly that this type of hedge fund is planning to comprehensively adjust its asset allocation strategy this year. 40% of the funds will be invested in stocks and bonds, and the remaining 20% will be used to buy cross-cycle assets such as equity investment and real estate trust Reits.
In addition, many hedge funds have also stepped up their hedging operations. In addition to buying 3 times the short-selling US stock index and US Treasury ETFs to hedge the risks of long US stocks and US debt positions, they also increased their efforts to buy US dollar bullish positions. They believe that while the Fed’s advance interest rate hike and balance sheet reduction have brought price revaluation to many assets, only the U.S. dollar will be the biggest beneficiary.
Reporters have learned from many sources that, given that the Fed’s advance interest rate hike and balance sheet shrinking have led to a rise in the U.S. dollar index, hedge funds have also begun to reduce the proportion of investment in the commodity CTA strategy, because the rise in the U.S. dollar index has put pressure on the rise in commodity prices.
“In addition to maintaining long positions in a few commodities such as crude oil where there is a tight supply and demand relationship, we have reduced our long positions in agricultural products and some metal futures.” A commodity investment hedge fund manager told reporters. Commodity investment hedge funds will also usher in a sudden increase in uncertainty in 2022. As the Federal Reserve raises interest rates in advance + shrinks its balance sheet, the price fluctuation trend of many commodities is quietly being reversed.
(Author: Chen Zhi Editor: Ma Chunyuan)
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