When Betting on QE Suddenly Goes Wrong

“As we can see with the bull market in China, once a bubble forms it has an internal logic of its own and it will grow until it has outgrown all of its surroundings,” wrote hedge fund manager Crispin Odey in a letter to his investors on May 28, after a fund in his $12.9-billion Odey Asset Management company had lost a breath-taking 19.3% in April alone and was down 18.2% year-to-date.

April was “bloody,” he wrote. Negative interest rates in Europe had created a bubble that would end “badly.” He’d been caught on the wrong side on multiple levels:

In hindsight the tail wind that was the leveraged position in the US dollar against Emerging Market currencies in particular, meant that I did not respond quickly enough to the aggressive QE introduced by Draghi in December of last year and the effects of the fall in the oil price two months earlier.

He wasn’t alone. Other bets that had worked for so long suddenly went wrong too.

Andrea Giannotta’s €3.7-billion long-term euro fund at Eurizon Capital had been up 6.7% in the first quarter, benefiting from the surge of long-term bonds as the ECB’s QE pushed down yields. But when the selloff hit, these bonds got whacked and have since given up nearly all of their gains. He expected yields to continue to go up, he told the Wall Street Journal. So there would be more pain.

“Fixed income had a great ride for a long time, but in the last few weeks we have lost a lot of money,” explained Tanguy Le Saout, head of European fixed income at Pioneer Investments. Their €4.9-billion aggregate bond fund lost enough money in April to wipe out most of the 3.1% gain in the first quarter. “People expect fixed-income funds to have a positive return, and the recent selloff is questioning that,” he said.

Euro bonds had surged for years as hedge funds had been front-running the ECB’s long-rumored QE that was finally announced as a €60-billion-a-month bond-buying program in January and implemented in March. They rode it up, driving bond prices to ludicrous levels, pushing yields of many government bonds below zero.

But just as ECB President Mario Draghi was declaring victory over we still don’t know what in mid-April, these hedge funds jumped ship – and overnight, German bunds became “the short of a lifetime.”

Hedge funds were dumping bonds and shorting them. No one else wanted to buy them, at these minuscule or negative yields.

This set off a rout during which €344 billion was lost on Eurozone-government bonds alone, according to Bloomberg, and with additional hefty losses on euro corporate bonds. As all this began to sink in, fund investors yanked nearly €2 billion from euro-bond funds in the past six weeks, the first major outflows in over a year.

“Bloody” as Odey had put it so eloquently.

The ECB rode to the rescue. This sort of turmoil went against everything it had tried to accomplish. So it announced that it would frontload some of its bond-buying spree ahead of the summer, under the pretext that this would avoid having to buy so much debt at a time when European market players would be on vacation and nothing could get done.

As far as the markets were concerned, the announcement meant an additional short-term mini-QE. It stopped the bleeding. Bonds recovered some, and yields settled down. By now, the German 10-year yield, after spiking from 0.05% to 0.77% during the weeks of turmoil, has dropped to 0.50%.

All this even though the ECB’s QE has barely begun. But it shows how these bouts of QE around the globe have perverted asset pricing mechanisms. The markets front-run QE as rumors and suggestions of QE run wild, and they’re driving up bonds and stocks in the hope of QE, as they have done in Europe, and when QE finally arrives as it did in March, stocks and bonds begin to sink. German stocks, for example, are down 7.4% from their peak in early April, after having shot up nearly 50% since October.

And so central bank jawboning, rumors of QE, suggestions of QE, promises of QE, and finally QE itself work in driving up markets – until someday, they don’t. And that’s when “unexpected” turmoil sets in.

Central banks think they’re omnipotent – until they aren’t. Read… Why the Bank of Japan Can’t Stop a Sudden Collapse of the Yen

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  16 comments for “When Betting on QE Suddenly Goes Wrong

  1. Vespa P200E says:

    I think bond bubble may unravel sooner than expected and take the equity and RE markets down with it.

    Paul Singer the old timer hedge fund managers (not those newly minted ones who was too young even for the 2000 rout) said mother of all short is brewing in the world flushed with too many longer term IOUs, consisting of FIAT currency. BTW – bonds are either paid or defaulted. Heck even Government Sachs and Gross the bond guru (and maybe Buffett too) said the same thing in last few weeks. The yield curve is ticking up/flattening and those who had faith in bond and its juicy return (value and yield) may be in for a shock that the bond value is about to deflate.

    That said – Singer has a very good advice: be careful on shorting longer term bonds as this mania may last bit longer till you know what hits the fan.

  2. Michael says:

    I hope you are right Vespa, I am really tired of the sheer nonsense. It would be a very good change to see this fake veneer fail and the criminals revealed. Our children do not have a chance if this continues.

    • Vespa P200E says:

      Sigh – I feel bad about the baby boomer generation (I’m at the tail end) saddling my children with unpayable national debt ($154k/taxpayer per link below), student debt and stick them with paying for SS knowing it will go BK sometime in the future, etc. Spending like drunken sailor via borrowing binges across the society sinking in debts does not bode well for our children as debt time can be kicked down the road (and getting bigger) so many times till it blows up.


      • Mark says:

        The Boomers lived through the good times. Generation X ( im somewhere in the middle born in the 70’s ) saw the end of those good times. The Millenials got the first taste of the bad times. Generation Z will see it worse. and so on and so on worse and worse with each generation until it gets better again.

        I’ll tell you what’s going to happen too. The Billionaires now will become Trillionaires in the next 20-30 years. So you’ll have Trillionaires, Billionaires and Millionaires. And the Millionaires pfftt.. they will be the new Middle Class with all the rest underneath them. And you will probably also have a new class of super poor people called the ” under class ” who basically have zero. And they will just be there running errands for the criminals and dying in the process. Im telling ya man, we are devolving back 150 years in terms of classes and wealth and it will be like this till at least the end of this century if WW3 doesn’t reset the system first.

        • Petunia says:

          Mark, you haven’t been paying attention. We are already where you describe. The millionaires are the new middle class. The rest of us are working class if we are lucky enough to have a job. The real underclass, your super poor, are the jailed population forced to work for pennies for giant corporations. Chris Hedges says the corporations consider these people the new “model employee”, shows up on time, makes no money, can’t complain. Where it will all end is either we become the slaves of the elites or we take our stuff back.

  3. Olaf says:

    So, the people selling these bonds, where are they putting their money? I thought the whole point of purchasing this kind of bond was that you couldn’t figure out where to stash your cash.

    • Wolf Richter says:

      Actually, for every bond that gets sold, there has to be someone with cash to buy it. So the market as a whole cannot pull cash out (unless a bond gets redeemed).

      And cash is not bad in iffy times. With bonds, you can lose a lot of money in a hurry. The bond bull market made us forget how risky bonds – and particularly bond funds – are!

      • Cordelia says:

        It seems likely to me that the historically extreme low yields on longterm bonds simply reflects an equilibrium price for credit given current expectations for inflation and the sea of liquidity that is currently looking for a home. Outside of the US, the tenor of Central Bank policy is still decidedly towards additional easing. It remains to be seen whether the Fed ever gathers sufficient nerve to press the trigger on its quarter point rise. Global growth, particularly in Asia, is in the doldrums, and despite the relentlessly optimistic rhetoric about an inevitable resurgence of growth in the US after negative Q1, recent data is largely lame. So where is the economic strength coming from that it going to drive equilibrium interest rates up? And commodities are struggling again, while a strong dollar depresses the price of tradable goods, which means any US increase in inflation is likely to be limited to services. Meanwhile, stock market valuations suggest a crash lies ahead sometime in the next two years, while probable longterm rates of return are near zero. So is a zero nominal rate of return (cash) really the best option out there? If so, that in and of itself supports the theory that longterm bond rates are closer to a real market equilibrium than a bubble. All the capital in the world cannot hide out in cash.

      • drdj says:

        Wolf, In your opinion where is the best place to hold “cash”?

        • Wolf Richter says:

          Not under your mattress. And certainly not in bond funds. Assuming you’re in the US: Some people own FDIC insured CDs from different banks in their brokerage accounts like others own stocks. Some open FDIC insured savings accounts with different banks and brokers to stay within the FDIC limit. For those who have a LOT of cash, that may be impractical. So they might hold short-term Treasuries outright. The purpose of cash is among others: to stay liquid so if there is an opportunity (a big crash, for example), you have the freedom to deploy it quickly and take advantage of that opportunity.

        • Chandra says:

          In 1929, the best answers would have included “under your mattress.” The problem with relying on the FDIC is that the “F” is F’ed up.

  4. Vespa P200E says:

    Latest from the muppets master Government Sacks:

    Goldman Sachs Warns “Too Much Debt” Threatens World Economy

    – Debt load of many countries is an economic risk
    – Ageing populations in developed world to put pressure on economies
    – Goldman proposes “creative” social policy to deal with looming crisis
    – Entire debt-based monetary system needs reform

    The debt burden – particularly in “developed” countries – along with ageing populations poses a risk to the economies of those countries, Goldman Sachs has warned. Andrew Wilson, Goldman Sachs Asset Management’s chief executive in Europe said, “There is too much debt and this represents a risk to economies. Consequently, there is a clear need to generate growth to work that debt off but, as demographics change, new ways of thinking at a policy level are required to do this.”

    Japan, as an example of a major economy, now has a government debt-to-GDP ratio of over 200%, which Wilson says is “not sustainable over the long term.” Other countries with very high debt loads include the U.S., most of Europe and Brazil.

    Wilson is particularly focussed on the issue of an ageing population.

    And from Goldcore’s perspectives: Unless and until the debt-based money system is reformed there will always be debt-related crises. Almost all currency today comes into existence as interest on existing debt. Debt cannot be repaid unless new debt is created. This process leads to ever greater amounts of debt.

  5. Chris says:

    Wolf, glad to know your point of view on the following…

    The reason WHY the Fed and CB’s did what they and did since ’08 needs better publicity. Why they changed from marginal manipulation via interest rates, etc. to outright “being the market” since ’08…why the big change??? And once you understand the problem, you understand why the Fed’s actions are criminal because they were never going to fix what was broken…this wasn’t an emergency or a liquidity issue.

    It was a “flow” (not “stock”) issue of new consumers that killed an already very flawed economic model. The annual “flow” of new population growth in the US, EU, Japan, elsewhere generally peaked in the ’80’s and annual new population growth began ebbing (link below shows it nicely). By 2008 in the US, the 25-54yr/old annual population change went negative. The sliding numbers of new consumers had been hidden for years by lower interest rates, more available credit (subprime, etc.), longer duration credit., etc. etc. But the ’08 outright annual decline of the new consumers was too much.

    The Fed and CB’s had to “suspend the free markets to save the free markets” (but what they really meant was they needed to suspend free markets because what a market would have done is found real pricing between lots of sellers and declining buyers).

    Everything now is simply trying to hide the fact we have shrinking consumer bases and will for a decade…and maybe for the rest of our lifetimes.


  6. dsdude says:

    this debt ponzi will collapse when the fed runs out of money. well that wont happen cause they’ll just print more… We can go on for another 50 years like this.

  7. ERG says:

    Chris, I’ve seen that article. While I think it is very pertinent, I also think what it describes can not be considered a cause for our present predicament. There is no substitute for honest money and an honest market and we have not had either of those for some time now. The demographic shift was an unexpected bolus of reality injected into a system that was Ponzi scheme from Day 1. All the shift did was remove the continual flow of Greater Fools entering in to the scheme. An honest system can handle changes like that. A dishonest one will not.

  8. Julian the Apostate says:

    Dsdude, your logic is flawed. Not only is the gov’t not printing money (they’re digitalizing it) there has been a flurry of trial balloons lately about outright banning actual hold in your hand currency. I believe they have geared way down on production of new bills. I have been pulling down my bank accounts to limit my exposure and have been watching the dates on the bill. Seems like 80% are 2009 10% 2006 and another 10% 2013. I have seen no bills from the intervening years, and the old style bills are gone. I did get one of these in change a while back (a $20) and that’s it. Seems like this has been in the works for a while. The dollar has lost 97% of it’s purchasing power and when they succeed at sucking the last 3% it will be basically worthless.

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