markets

What We Learned From a Week With London’s Fund Managers

Updated on
  • Bloomberg markets blog met with some 20 fund managers, traders
  • Trade war, China devaluation, tech selloff top the worry list
Pimco CEO Roman Being 'Cautious' on Interest Rates

Beware higher bond yields, watch for a stronger dollar, and steer clear of credit.

Those are some of the biggest consensus calls from London’s money managers as they navigate financial markets rocked by central bank tightening, the threat of trade wars, and concern global growth has already passed its high water mark.

In the week that 10-year U.S. Treasury yields climbed above 3 percent for the first time in four years and the dollar hit its strongest level since January, Bloomberg took the pulse of some 20 traders and money managers in the City. The following is a look at their cross-asset views and the risks they’re monitoring. They asked not to be named as their positions are confidential.

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Dollar Dilemma

The vast majority of London-based funds agree that more dollar strength is likely for the weeks ahead. But they’re split between whether it’s at a long-term turning point, or simply seeing a bounce within a secular downtrend.

That’s reflected in the broader market: Commodity Futures Trading Commission data show net non-commercial positioning remains bearish on the greenback, even after recent gains took the Bloomberg Dollar Spot Index to levels last seen in January.

Dollar bulls will be encouraged by U.S. yields, which, buoyed by the Federal Reserve’s tightening monetary policy, are starting to reassert their influence over the currency. The correlation between rates on two-year Treasury notes and the dollar is firmly back in positive territory after turning negative in February and March for the first time in more than a year.

The greenback strengthened against all its major peers on Tuesday as European currencies from the euro and pound to the Polish zloty and Swedish krona crumbled. That sent the Bloomberg Dollar Spot Index above its 200-day moving average for the first time in almost a year.

Bond Woes

London-based hedge-fund managers are putting their faith in bear-steepeners in the U.S. -- a bond selloff with yields on the longest-maturity debt leading the way. Still, the so-called real-money sector is less convinced. One key concern among the former is that investor appetite for Treasuries is faltering just as the U.S. ramps up issuance. As a result, London traders are keenly monitoring demand at Treasury auctions for signs of ebbing demand.

This debate is coming to a head as the Treasury prepares to give its refunding announcement on Wednesday, in which it’s expected to signal larger auction sizes across all maturities. The betting is that, given the large amounts involved, the U.S. will eventually have to shift the issuance mix toward the longer-end of the curve -- something it has so far refrained from doing.

For U.K. gilts, steepeners have also been a consensus theme of late. Before Friday, most investors were expecting the Bank of England to raise interest rates in May, so there will have been widespread pain caused by the first-quarter gross domestic product figure, which fell short of analyst estimates with growth of just 0.1 percent.

On the plus side, for the first time in two years, Brexit isn’t a dominant topic in conversations with the money managers.

Stock Nerves

There’s a notable divide among London’s market participants when it comes to equities: hedge-fund managers, typically faster to react to changes in the macro environment, are inclined to be more bearish than slower-moving real-money managers.

After cresting at a record high on Jan. 29, the MSCI All-Country World Index has lost more than 7 percent, raising concern that the long-term bull market may be coming to an end. Worries that the tech sector, which dominates U.S. equity markets, is overvalued and losing momentum are oft-cited in London as a reason to beware further stock-market weakness.

That isn’t the only misgiving surrounding higher-yielding assets, though. The consistent view from those who attended this month’s Washington G-20/International Monetary Fund meetings was that the probability of a detrimental trade war is far greater than seems to be priced into markets.

Escalating protectionism could once again become a key risk. While the Trump administration said Tuesday it is to delay imposing steel and aluminum tariffs on the European Union, Mexico and Canada until June 1, the extension just prolongs a standoff with the world’s largest trading bloc.

Currency Calls

London money managers fear the broader market has an overly-complacent conviction that the U.S. will avoid a hard line on trade, a concern that’s leading them to the view a trade war will only be averted with major concessions from the Chinese.

Tied to that, a significant yuan devaluation is a tail risk garnering serious discussion, because a protectionist showdown may give China the cover for a move it wants to make anyway. When the country unexpectedly devalued the yuan by 2 percent back in August 2015, it fueled capital outflows and sent shock-waves through global markets.

Meanwhile, bullish yen is a surprisingly consensus view among London investors, especially since so many have also been positive on the nation’s stocks.

Perhaps they feel the currency is simply too beaten up. While it surged 4.9 percent on a trade-weighted basis in the first quarter, the yen has weakened in four of the past five weeks. And though the central bank has maintained a dovish stance, there has been increasing speculation that it may be getting ready to take its first steps away from its currency-debasing stimulus measures.

Credit, Crunched

Credit bulls are an extinct species in London. Not everyone is abandoning the asset class, but very few see scope for gains, given the narrowing in credit spreads.

A more bearish outlook on credit has certainly been reflected in market positioning in recent months. In the U.S., for example, speculators have been circling the iShares iBoxx Investment Grade Corporate bond ETF, sending short interest to the highest in more than seven years in March, according to IHS Markit Ltd. data. The measure has since fallen, but still stands at more than two percentage points above the four-year average.

Emerging Bulls

Finally, there’s a jarring inconsistency in the view on emerging markets. Despite hedge fund managers predicting higher yields and lower global growth, and being generally negative on credit and equities -- which are all normally bad for EM -- no-one seemed particularly concerned on developing markets themselves.

A number of people highlighted Turkey as providing an opportunity ahead of its summer election. In that market at least, it seems the lure of yields at 13 percent is hard for London’s investors to ignore.

Terminal users can get more insights like these from Bloomberg’s Macro Views.

— With assistance by Dani Burger

(Adds today’s dollar move in paragraph under first chart, and Mnuchin video clip.)
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