How some hedge funds would trade a rate cutting cycle

LONDON – While many investors hope falling interest rates will usher in a soft economic landing, others forecast a calm before the storm.

Here are hypothetical trading ideas shared by three hedge funds on what is next for the US and global economies at the start of a US easing cycle.

Markets fully price in a quarter-point rate cut and a 60% chance of a bigger 50 basis point cut later on Wednesday.

They said regulations prevented them from revealing their actual trading positions or making recommendations.

1/ CONFIDO CAPITAL

* Amplified income strategies

* Launched in 2024

* Key trade: Short risk assets, buy protection on high yield credit

Brad Boyd, founder of Confido Capital, said the anticipation of lower rates has fuelled rosy equity and credit price levels that creates an asymmetry of risks in the market.

He said he would short any kind of risk asset like stocks, the bonds of companies which might have a low-quality balance sheet, real estate or emerging markets. Specifically, he would buy credit default swaps, sometimes likened to a form of insurance in bond markets.

A short position bets that an asset’s price will fall, while a long position bets on a rise.

Rather than pick a particular company, Boyd would take long positions via the index, HY CDX, a basket of credit default swaps, or insurance premiums on 100 high yield bonds in the US

In the short term, Boyd warned that markets were overpriced for Fed easing and could take a hit if cuts did not live up to expectations.

“There could be plenty of hand-wringing and crying in the streets,” said Boyd.

2/ MONROE CAPITAL

* Direct lending and alternative credit solutions

* Size: USD 19.5 billion

* Founded in 2004

* Key trade: opportunistic buying in secondaries markets

Kyle Asher, managing director and co-head of alternative credit solutions at Monroe Capital, would look to the secondaries market to see Fed rate cuts play out.

Secondaries markets trade financial instruments such as stocks, bonds and loans — most often from private equity investors — but also from any investor selling to another investor.

“The rate cuts will buoy many sectors that will benefit from paying lower interest rates on their loans including software, business services, and media companies,” said Asher.

Fed rate cuts typically filter out across the economy, pushing the cost of borrowing for corporates and consumers down.

“A lot of the more medium-sized private companies have loans trading around 70 to 80 cents which will see their cash flow rise when the cost of borrowing falls,” said Asher.

As the cost of servicing their debt falls, companies will be able to spend more on measures that boost their production, their growth such as research and development, more marketing and more staff, added Asher.

3/ ANALOG CENTURY MANAGEMENT

* Hard tech-focused long/short fund

* Size: USD 1.8 bln

* Founded in 2018

* Long chip makers for auto and industrial applications

Val Zlatev’s hedge fund Analog Century Management is focused on hard tech, meaning companies that manufacture semiconductors, communication equipment and system hardware.

He divides them into two groups: secular growth companies and manufacturers that are much more exposed to mature applications spending such as the hardware that goes into smartphones and PCs.

“Semiconductor stocks exposed to industrial and automotive have been suffering for quite a while. Revenues have fallen and many have technically been in recession already for a number of quarters,” said Zlatev.

If falling rates rejuvenate industrial spending and make it easier for consumers to borrow money to buy cars, earnings will expand and that will be reflected in the stock price of these companies, he says.

(Reporting by Nell Mackenzie; Editing by Dhara Ranasinghe and Alexander Smith)