No longer walking on water
Overnight the Bank of Japan flooded the market with yen, allegedly buying US$1bn as it, like the Swiss National Bank, tries to weaken its safe haven currency. It will be fascinating to see what follows. The financial crisis has done much to undermine the reputation of the hedge fund industry which for years appeared to walk on water. The uncertainty of the past months has demonstrated that, in all, it has no better recipe for boiling it.
Back in the seventies and eighties, just as forex was becoming a major industry, the call of “The central banks are in…!” would have traders rushing for cover. There was little that caused more fear on the trading floor than being on the wrong side of the monetary authorities when they decided that the market had had its own way for long enough and to intervene.
Two of the most mercurial central banks, however, which were not managing their own currencies but merely the reserves, were Bank Negara of Malaysia and the National Bank of Hungary, the London subsidiary of which I worked at for a while. There was a legendary event when the bank, it was called Hungarian International Bank, began tidying up some odd-lot sterling/deutschmark positions on the book at the end of the day. The dealer checked a few prices in the Street and before you could say “Jack Robinson” the sterling/mark market went into overdrive – “The Hungarians are in!” No they weren’t; they just wanted to go off to the pub with a flat book.
Alas, the rise of the macro hedge funds in the nineties changed the balance of things as they, when fully leveraged, could take on the central banks at will. If they had decided to push a currency one way or the other and the respective central bank came to intervene, the hedge funds could take them on and leave them standing as their collective fire-power massively outshone that of the monetary authorities. Central bank intervention began to fade, not least of all after George Soros had famously given the Bank of England a very bloody nose in 1992. Small actions continued to take place and very occasionally the banks would come out to play together in “concerted action” although in the past few years that has become less and less common. The BoJ did intervene in the aftermath of the earthquake and tsunami but it was last night’s action which really moved things.
So where are the hedge funds? Could it be that they have lost some of their teeth and, more to the point, some of their courage in taking on the power of the state? It was quite evident at the outset of the European government debt crisis that the senior firms were not part of the attack on Greece. I understand that for example Alan Howard, principal of the mighty Brevan Howard, did not want to play around with the reputational risk which would be attached to being seen to be profiting from governments in trouble.
After Greece’s utterly unjustified swipe at the hedgies when it completely screwed up its five-year bond auction in January last year and then tried to blame the hedge funds for the mess, the latter have broadly become more cautious. With them all desperately trying to dodge invasive regulation and with the volatility in the markets which has made almost everybody look ordinary, the appetite to bare one’s chest and cry “Bring ’em on!” has significantly diminished. The lack of market liquidity and the increase in the cost of leverage will also have made facing down the central banks more difficult. We went home with the dollar/yen trading at around ¥77.10. This morning it is ¥79-1/2 and there is nobody out there holding against it.
Over the coming months we are undoubtedly going to see some significant changes in the investment banking environment, not least of all in the form of some serious retrenchments. I wonder whether, along with this, we will see a further weakening of the power of hedge funds as the key directional drivers? If so, it will not be long before incompetent politicians begin to sentimentally think back to the days when they could blame the results of all their mistakes on those horrid and greedy geeks in Mayfair and in Greenwich. Why am I getting nostalgic about the future? Well, I guess not even the future is what it used to be – and, without leverage, probably even less so.