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Market Extra: Treasury liquidity is worsening as hedge funds Rokos and Alphadyne reportedly incur losses from wrong-way bets on yields

Rokos Capital Management and Alphadyne Asset Management are being identified by Bloomberg News as two of the large hedge funds that have incurred losses as a result of wrong-way positions on government-bond yields.

Yields across the world have unexpectedly converged on growing expectations of tighter policy from central banks and a darkening global outlook. The accompanying volatility has caught a number of leveraged players off guard — and is now leading to deteriorating liquidity in the Treasury market, as well as in Europe, Canada, and the U.K., according to BofA strategists.

See: Fed seen announcing start of a ‘taper’ of bond purchases this week

The volatility comes as traders readjust their expectations for future rate hikes by global central banks on persistent inflation pressures, pricing in such moves sooner and more aggressively than previously expected. That’s led to the recent, pronounced flattening of bond-market curves from the U.S. to the U.K. and Australia at a time when many firms had expected yields to diverge, curves to steepen, and economies to bounce back.

Read: Hedge funds seen facing heavy losses amid wrong-way Treasury bets ahead of Fed tapering, traders say

Hedge funds, which were using leverage to amplify their returns, are said to be experiencing sharp losses, which in turn is reducing their capacity to take on more risk. Rokos’s hedge fund sank 11% in October, partly because of wrong-way wagers on U.K. and U.S. yields, according to Bloomberg, which cited people familiar with the matter. Most of the damage was reportedly done by the market’s shift to sooner-than-expected hikes by the Bank of England. Rokos didn’t immediately respond to an email seeking comment.

Meanwhile, Alphadyne is said to have lost more than 1% in October and incurred year-to-date returns of minus 13% through Oct. 22, according to Bloomberg, citing people who requested anonymity. Not only did Alphadyne hold some bets that the Treasury curve would steepen, but the firm also wagered on a steeper yield curve in continental Europe, Bloomberg said. A media representative for the firm didn’t immediately return a call seeking comment.

Also see: What Federal Reserve tapering means for markets

Ordinarily, the Treasury market is the deepest, most liquid fixed-income market in the world, so fissures in its functioning can spill over into the rest of the financial system.

“These moves have exposed still fragile UST market conditions,” strategists Mark Cabana, Ralph Axel and Meghan Swiber wrote in an Oct. 29 BofA Global Research note released Monday. “Near term there are some Band-Aids that might support UST market functioning. However, medium term challenges remain.”

The deterioration is “most clearly seen” in the 20-year Treasury bond and has also “reverberated” to the 7-year part of the curve, Treasury inflation-protected securities and the front end, where measures of market depth for 2-year futures are the thinnest since February, the strategists said.

On Monday, Treasury yields were headed higher ahead of this week’s Fed meeting in Washington, with the benchmark 10-year rate
TMUBMUSD10Y,
1.584%

hovering around 1.53%. Meanwhile, the Dow industrials
DJIA,
+0.18%

and Nasdaq Composite Index
COMP,
+0.43%

kicked off November with gains in early trading.

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