By Richard Leong
NEW YORK (Reuters) – The dollar’s four-week decline and a slump in bond prices has upset some assumptions about where global financial markets are heading, but haven’t deterred most investors from staying faithful to their bets.
At the beginning of the year, a weak global economic environment combined with central-bank support made some trades seem like sure winners: buy the dollar, buy bonds, sell oil, and buy stocks. After the last four weeks, with the dollar sliding, oil rising above $50 a barrel and a rebound in inflation expectations, only the equities bet is left standing.
Still, most investors interviewed by Reuters said trades based on expectations for lower bond yields and a higher dollar will regain their attraction. They called the recent market moves more “technical” in nature.
“What we have really seen this month is a correction as opposed to a turn,” said Mark Astley, chief executive officer at Millennium Global, a $14 billion currency specialist based in London. He expects the euro to resume its fall later this year.
One reason for a shift in investor sentiment was a resurgence in Europe, prompting some fund managers to invest more heavily in European stock markets.
“The unwind we have seen of these crowded trades in the past few weeks has everything to do people far too long Bunds and a recognition that the European economy has recovered a bit,” said Kate Moore, chief investment strategist for U.S. with J.P. Morgan Private Bank in New York.
The euro has risen 9 percent to $1.14 since hitting a 12-year low against the dollar on March 16, on signs that Europe has escaped a downward price spiral because of a weaker euro, engineered by European Central Bank’s 1.1 trillion euro quantitative easing program.
Thanks to the brighter outlook on Europe, the $11 billion New York-based hedge fund Jana Partners upped its stakes in the region’s equities, adding positions in Euronav NV <EURN.N> and iShares MSCI Germany exchange-traded funds <EWG.P>, according to regulatory filings.
Euronav shares were up 16 percent since March 31. The Germany EWG ETF is up 10.3 percent on the year, handily beating the 3.8 percent rise of the Standard & Poor’s 500 index <.SPX>.
“We think both European economic growth and profits growth will outstrip expectations,” said Chris Darbyshire, chief investment officer at Seven Investment Management in London, which has $14 billion in assets.
Whether the support from the ECB is enough to offset an increase in U.S. benchmark lending rates is another question. The Fed is still expected to end its near zero interest rate policy later this year. That unknown means, according to strategists at Bank of America/Merrill Lynch, that returns will remain mediocre, with “volatile trading” as investors rotate from one asset class to another, as well.
“There is going to be a lot of fits and starts for the market,” said Putri Pascualy, a managing director at PAAMCO, which oversees assets of $9.5 billion in Irvine, California.
STICKING TO BETS
For U.S. Treasury bond funds, the shakeout over the last month has wiped out their earlier gains. Fidelity and Vanguard’s long-dated Treasuries funds, <FLBAX.O> and <VUSTX.O>, worth about $1 billion each, were among the biggest losers in their category, falling 5.3 percent during the sell-off, according to Lipper, a Thomson Reuters unit.
Some managed futures funds that focus on financial futures and options suffered steep losses during the initial market move as well. In the last 30 days, managed futures funds tracked by Morningstar fell 5.1 percent, and are up just 1.2 percent on the year.
Many of those funds were hit as oil prices recovered, a bet that also made a loser out of Citibank, which three months ago forecast U.S. crude prices tumbling to $20 a barrel by about the end of the first quarter, due to a global supply glut.
After bottoming at a near six-year low in mid-March, U.S. oil futures have risen over 40 percent to $59.54 as of Friday, and the rise in oil prices propelled inflation expectations in Europe and United States to their highest of the year.
BOND MARKET SHAKEOUT
The shakeout in the bond market was arguably more painful, worsened by thin liquidity that traders blame on tighter regulations. And the dollar’s move meant those bullish on the greenback saw two-thirds of their profits generated in the first quarter evaporate in a matter of weeks.
The benchmark 10-year Treasuries yield <US10YT=RR> was 2.22 percent on Monday, up from 1.85 percent a month before the bond market rout. Ten-year German Bunds <DE10YT=RR> were last at 0.65 percent, up from 0.10 percent a month earlier.
The backup in bond yields has not yet deterred investors. They put in $1.96 billion into global bond funds in the latest week, Bank of America Merrill Lynch said on Friday.
Speculators still bet on the euro to fall. Futures positioning showed their net short position totaled $25.1 billion against the euro in the latest week, $1.5 billion less than a week earlier but still substantial enough that more strength in the euro will hurt investor returns.
Jeffrey Gundlach, the widely followed co-founder of DoubleLine Capital, said earlier this year that investors should brace for a spike in yields. He expects dollar weakness to abate in the near-term.
Gundlach’s MBS-centric <DBLTX> intermediate-term bond fund is up 1.6 percent for the year, outpacing the comparable Barclays benchmark’s return of 1.24 percent.
(Additional reporting by Gertrude Chavez-Dreyfuss, David Gaffen, Jennifer Ablan and Sam Forgione. Editing by David Gaffen and John Pickering.)