Minyan Mailbag - Dollar, Other Bets
Note: Our goal in Minyanville is to remove intimidation from the financial markets and encourage an interactive dialogue among the Minyanship. We share this next column with that very intent.
For FX traders the equation for the buck is simple. All else being equal, you sell the currency with the lowest rates growing at slowest pace [which was the dollar until recently] and buy the currency with the highest and fastest rising rate. Of course there are other factors of legitimacy, debt, etc. but that is basically what folks do. On the other bets front, we have a real interesting situation. It seems like markets have been surprised by the Fed action. My read on what most hedgies are set-up like is:
- short dollar
- possibly long euro
- short bonds [treasury which is working at the short end anyway]
- long junk/corporates [which look like they may stop working]
- long emerging [which will get hurt on higher dollar/lower commodity prices]
- long commodities [which get hurt with higher dollar]
- long stocks, particularly interest rate sensitives and energy/materials
[I'm exing out a lot of the short interest as I think despite the wailing about it, it's about 4 days of single market activity and a lot of it is hedges against long corps/converts.]
There is lots of liquidity sloshing around out there, with excessive bullishness.
Why do I sense only two of these seemingly non-correlated [but heavily so] legs need to get blown out to have a genuine old-fashioned crisis?
Why do i think it's happening right in plain sight while few expected it?
Hedge funds should not be operating in this fashion.
A "hedge" by definition should not have any chance of becoming more correlated. For example, the correct hedge for long stock is a short call or long put. The relative correlation can change but cannot go positive. In this case, risk can be quantified.
When hedge funds operate directionally (which we don't), they can fall into the trap of believing they are hedged because of historical correlation between long and short assets. When these correlations change the hedge fund could experience unexpected gains or losses.
The exposures you list below do not even incorporate any of the above discussion and illustrate little risk control, but reflect either fundamental positions or momentum trading.
I agree. The problem is hedgies have changed, in part [enough to make life tough for everyone] operating as simple momentum driven leveraged return funds. That works great until it doesn't. I may be talking through my rear end but this is a change I detected in operating mode from 2002 on where the vast majority of new funds formed were by former sell-siders from the big banks. I am sure they were very capable salesmen and desk traders when the house ran the show, outside those confines, not so smart. That's my best guess just given the way I see things sloshing around out there.
Bingo! - John
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