Uncle Al's Conundrum VI - The Hedgsters
Foreign Central Banks like China and Japan are one component of Uncle Al's conundrum. The hedge funds are another. For the last four years, highly leveraged hedge funds have had a field day in the carry trade. They have locked in guaranteed profits by borrowing short term at 1% using repo or swaps (repurchase agreements, interest rate swaps), and investing long term in Treasuries and MBS (mortgage backed securities).
But there is always a catch. That being, provided long term interest rates do not go up. The Fed keeps raising the short term rate, yet the bond market has only recently begun to budge at the long term end. This is only the beginning of an unwind in hedge fund positions in the bond market, which directly influences interest rates, and the hedge funds are resisting with all their might.
The hedgsters are like margin traders, only on a much larger scale. Their strategies are propping up values across the board. The hedgsters have helped to run up individual stocks (Google), homebuilders, raw materials and the energy sector to all time high valuations. By shear leverage, the hedgsters have managed to help keep long term interest rates artificially low and cause a severe decline in the value of the dollar.
In part, the hedge funds are responsible for the resulting global over liquefaction and asset bubbles that the easy money has created Or are the hedge funds just acting innocently, as a part of the market, which when presented with the opportunity to make easy money, will always do so?
Due to their highly leveraged nature, much like a margin buyer, the hedge funds positions in the markets are at a much higher risk premium. When a gross distortion in one direction is created, it tends to be met with an equal reaction when the market unwinds. This leaves long term holders and small investors caught in a tsunami when the hedgsters and speculators all head for the exits at the same time and the bottom drops out. Not everyone can fit through the doors at once.
By pouring money into long bonds, hedge funds have helped to suppress real interest rates, spawn global asset bubbles and increase overall market risks. The resulting distortion of markets and misallocation of capital, towards investments which bring short term profits, but long term do not sustain economies, is abnormal and economically unhealthy.
This leads to a larger moral question; If the action of hedge fund investment strategies has collateral damage to the U.S. and global economy, should it be further condoned?
But there is always a catch. That being, provided long term interest rates do not go up. The Fed keeps raising the short term rate, yet the bond market has only recently begun to budge at the long term end. This is only the beginning of an unwind in hedge fund positions in the bond market, which directly influences interest rates, and the hedge funds are resisting with all their might.
The hedgsters are like margin traders, only on a much larger scale. Their strategies are propping up values across the board. The hedgsters have helped to run up individual stocks (Google), homebuilders, raw materials and the energy sector to all time high valuations. By shear leverage, the hedgsters have managed to help keep long term interest rates artificially low and cause a severe decline in the value of the dollar.
In part, the hedge funds are responsible for the resulting global over liquefaction and asset bubbles that the easy money has created Or are the hedge funds just acting innocently, as a part of the market, which when presented with the opportunity to make easy money, will always do so?
Due to their highly leveraged nature, much like a margin buyer, the hedge funds positions in the markets are at a much higher risk premium. When a gross distortion in one direction is created, it tends to be met with an equal reaction when the market unwinds. This leaves long term holders and small investors caught in a tsunami when the hedgsters and speculators all head for the exits at the same time and the bottom drops out. Not everyone can fit through the doors at once.
By pouring money into long bonds, hedge funds have helped to suppress real interest rates, spawn global asset bubbles and increase overall market risks. The resulting distortion of markets and misallocation of capital, towards investments which bring short term profits, but long term do not sustain economies, is abnormal and economically unhealthy.
This leads to a larger moral question; If the action of hedge fund investment strategies has collateral damage to the U.S. and global economy, should it be further condoned?
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