Eric Peters: "So You Guys Are Making Money, Who’s Losing It?"

Submitted by Eric Peters, CIO of One River Asset Management

“My guys out there all have 4-5 things going on,” said the CIO, excited, his army of traders sprawled across Gotham.

“They tell me this curve is distorted, that one isn’t. This price is out of line but not that one. They’re doing things in cash bonds versus futures. They box trades and hedge out idiosyncratic risks.”

Relative-value rates trading is offering real opportunities this year. Firms with decades in the space are reaping the rewards. “But it’s that time of year when we have to decide what to hold over year-end. What to sell. Got to take down our balance sheet.”

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“So you guys are making money, who’s losing it?” I asked. When you pick up pennies and leverage it for a living, it helps to know who’s dropping them and why.

“Distressed sellers? ETFs? Bid/ask spreads widening? Are your guys getting paid to provide liquidity?” I asked.

He smiled, then answered, “Bond issuance is rising. Endless trillion-dollar deficits are just starting. And the runoff from the Fed’s balance sheet reduction keeps coming. Auctions are getting sloppy. Most people haven’t seen this environment. So now lots of people are paying us.”

“Our industry has still not adjusted to Dodd Frank,” explained the same CIO. “When markets aren’t really moving, it appears everything is fine. But when there’s any kind of volatility, it’s a very different story.”

A decade of infinite liquidity lulled us to sleep. It’s over. We’re waking. Repo rates surged Tuesday, inexplicably.

“Here’s an example: money market funds can’t lend to me. So they give cash to banks, and I get it from them, but that bloats their balance sheets, which they’re desperate to shrink. And this distorts rates, creates inefficiencies.”