End-quarter factors added fuel to Fed-sparked sell-off

06/28/2013

* Timing, market positioning added to sharp market moves

* Any lull may only last until non-farm payrolls on Friday

* Volatility begins path to long-term average

By Simon Jessop

LONDON, June 28 (Reuters) - U.S. Federal Reserve Chairman Ben Bernanke may have lit the touchpaper on the market rout of recent weeks, but some of the fuel was rather prosaic.

The sharp financial market swings caused by his comments on May 22 about scaling back monetary stimulus were compounded by seasonal and other factors that should be absent in early July, even as the panic over an early end to stimulus subsides.

Among them were the need for some fund managers to make forced changes to their investments to align with their benchmarks, mid-year hedge fund redemptions, and a step back from over-exposure to popular trades.

Together they stirred up many billions of dollars throughout markets and that drove volatility higher, even without the stimulus talk.

There is no argument, of course, that Bernanke's and other Fed comments had a huge impact. Euro zone stock gains, for example, were wiped out for the year.

But the desire of many funds to take money off the table, either to park it on the sidelines before starting again in the second half or to return cash to investors, added to the relative rout.

"A lot of the disruption... has been caused by the hot money," said Stephen Walker, head of equities research and market strategy at Ashcourt Rowan, which manages 1.5 billion pounds ($2.31 billion), referring to hedge fund trade strategies that are often more nimble.

"We've had a very rapid (market) adjustment and it coincides with fairly large hedge fund redemptions at the end of this month. Hedge funds... were quite big net sellers this month."

One reason, according to data from hedge fund administrator SS&C GlobeOp, was an increase at the half-year mark in the amount of money investors asked to be withdrawn.

OVER-POPULAR

In the meantime, many trades were becoming too popular, with a huge demand for assets such as U.S. Treasuries, and emerging market and peripheral euro zone debt. So when the stampede to the exit began, it was more unruly than might otherwise have been the case.

"Bernanke's speech was really just the match that lit the flame. When you look at the positioning that we had in the markets and the excessive amounts of carry trades, it was an accident waiting to happen," said David Keeble, global head of fixed income strategy, at Credit Agricole.

Using the quarter- and half year-end period to book profits and reduce risk made a lot of sense, Guillermo Felices, director in Asset Allocation Research at Barclays, said.

Among those doing so were funds that had to. Many buy and sell assets at the end of a defined period, usually the quarter or half-year, so that their holdings more accurately reflect the benchmarks against which their performance is judged.

Others, such as tracker funds, needed to buy and sell as a result of changes to indexes by providers like FTSE. Such a process, called rebalancing, can result in trades totalling hundreds of billions of dollars globally, although the actual figure is not precise, a London-based portfolio trader said.

"You'd expect to see a lot of that rebalancing trade done at the end of the month. The fact that, so far, volumes have been light, suggests a lot was done earlier in the month, after the Fed comments," he added.

NO RETURN

Central bankers across the world have sought to soothe markets, suggesting any end to stimulus is a long way off. It has worked to some extent, but that does not mean a return to the way things were.

Stephane Deo, global head of asset allocation at UBS, said that the Fed stimulus, which pumped money into the financial markets, killed volatility. That has now been reversed.

"The volatility we've seen since the announcement has been a little bit excessive, but we're entering a phase of greater vol," Deo said.

Stock market volatility on the U.S. Standard & Poor's 500 is up 30 percent since Bernanke spoke, and could well return to its long-run average of around 20 from its current 17, Deo said, a potential 50 percent rise from end-May.

Volatility in the currency markets, meanwhile, as measured by one-month expectations of movement in the euro/dollar rate has risen from a December low of 6.3 percent to 8.4 percent. (Additional reporting by Anirban Nag, Francesco Canepa, Ana Nicolaci da Costa, Atul Prakash, Toni Vorobyova, Marius Zaharia, Richard Hubbard and Alistair Smout; editing by Jeremy Gaunt)



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