As investors in macro strategies for more than 20 years, we have witnessed this style of investing written off on numerous occasions. There is a cyclical nature to macro and we understand the strategy can struggle especially in periods of low volatility. This is especially typical during prolonged equity bull markets, as evidenced most recently in the mid-2000s, when volatility was grinding lower across all assets. But volatility returned each time and macro rebounded strongly.
A macro trader is essentially doing the same work as a bottom-up stock picker, but looking at the fundamental health of the economy – such as employment, growth and inflation, and understanding if monetary policy as a reaction function is appropriate or not. Typically the greatest trading opportunities have presented themselves when discrepancies exist between fundamental economic data, market prices and monetary policy.
It is important to highlight that historically the majority of a macro trader’s returns have come from trading interest rates and currencies. While this playbook has traditionally served macro well, it has been difficult to trade post the financial crisis in 2008. Central banks, led by the US Federal Reserve, have embarked on quantitative easing and effective forward guidance in monetary policy that has led to successful suppression of volatility – especially in interest rates and currencies. Front-end interest rates in particular, a core instrument for macro traders, have been anchored close to zero in major developed markets, which has taken out a major tool from the macro trader’s toolkit.
As investors in macro for a very long time, to us it is no great surprise that discretionary macro traders have struggled in this environment. While returns have been sluggish, it is important to highlight risk management is inherent in the DNA of a discretionary macro trader and the strategy has not lost money in what has been a very difficult environment. However, we believe maybe there is light at the end of the tunnel.
Starting mid-way through 2014, we have seen a pick-up in currency volatility as monetary policy divergences between the various global central banks have become increasingly apparent, as economic growth has diverged. It is no surprise macro traders have posted strong returns in the last six to nine months. Even in the more fallow period for macro between 2011 and 2014, traders have done well during short periods of market volatility – such as the fourth quarter of 2011 or the taper-tantrum in 2013. This highlights macro’s usefulness from a portfolio construction perspective.
We believe monetary policy divergence will continue to be a theme in the medium-term, as the Fed sets the stage for a potential rate hike in the near future and other major central banks, such as the European Central Bank and Bank of Japan, do the opposite with monetary policy easing. In fact, outside of the major developed markets, there were over 25 monetary policy decisions made around the world in Q1 this year. Individual countries are now responding to their own economic fundamentals, as opposed to purely what the Fed is doing. Just as a fundamental stock picker requires dispersion in stock prices, a macro trader requires interest and currencies to behave in a fundamental manner. This increasing dispersion in currencies and interest rates on the back of monetary policy divergence has led to fertile trading opportunities.
In the last few months we have seen major policy decisions, such as the Swiss National Bank removing the floor on the franc’s value against the euro in mid-January. We have also seen aggressive monetary policy easing by several countries, as commodity prices have declined sharply and heightened fears of possible deflation. On the other hand, there have been idiosyncratic stories, such as in Brazil, where its new post-election economic team has embarked on interest rate hikes and monetary policy orthodoxy. Then there is the most recent development in China, where the People’s Bank of China took a decision to ease monetary policy as growth trends lower.
After an unusually long period of calm in financial markets, there is now simply a lot more going on around the world. Markets are grappling with changes to commodity prices, questions around economic growth and extremely low yields in bond markets. Macro is the classic go anywhere, trade anything strategy. As volatility returns to markets, so does the opportunity to take advantage. It certainty does feel like we are returning to a more ‘normal’ phase for markets.
Key takeaway: Recent low volatility has hurt macro traders. A looming divergence in monetary policy will help to bring the strategy back in favour.
Akshay Krishnan is manager of the Stenham Macro Ucits fund.