The great unwind

For all that market commentators focus on economic fundamentals, most of what has been happening this year has been about liquidity – or more specifically the impact of the withdrawal of over $3trn of liquidity from markets by central banks as quantitative easing has been flipped to quantitative tightening. This has led to the start of the ‘Great Unwind’ of carry trades and leveraged positions built up over a decade or more of QE and inappropriate levels of ultra-low interest rates – although the members of the Nobel Prize committee would appear to disagree and indeed to approve of the years of the ‘Bernanke Put’.

Long term investors have nevertheless taken notice of the change of regime to a ‘Powell Call’ and, sticking with the mantra that there is ‘no sense in fighting the Fed’, have flipped from buying the dips to selling the rallies. This selling, combined with the steady pressure to deleverage, has produced periodic bouts of illiquidity and distressed selling as well as a series of bear squeezes and false breakouts making markets extremely nervous and choppy.

Meanwhile, as volatility has risen across the board, this has triggered further de-leveraging and systematic risk into markets. The latest example has been the forced unwind of, largely hidden, leverage in the UK pensions system that required the Bank of England to step in as buyer, rather than lender, of last resort.

As a result, this has been a tremendous year so far for Macro Hedge funds, and a terrible year for almost everyone else, especially anyone in the long only space, where outperforming has meant simply not going down as much as the rest of the market.

Indeed, for many non-US $ based investors, the only way they have kept losses in single digits has been by being long US$ assets, the currency effect delivering them anything between 10 and 20% uplift in local currency terms. As a result, the favourite trade of the Macro Hedge Funds – long US$ against virtually everything – has also become the default trade for long only, making the US$ index perhaps the most crowded trade out there and the $ therefore the key indicator to watch. As and when it turns, the need to ‘book profits’ will be powerful indeed and the flow of liquidity out of US $ cash into non $ ‘value’ assets is going to determine the next phase in markets.