If the pundits are correct, the markets have baked in the potential impact of a Federal Funds rate increase. The Federal Open Market Committee (FOMC) will meet December 13 and 14, after which its decision with respect to a rate hike will be unveiled. In this continuing milieu of uncertainty, markets have responded by assuming the probability of a rate hike is high and making adjustments based on that premise. Less clear is the tack hedge funds, particularly those pursuing long/short equity strategies, have elected to follow.
Post Election Market Is Bullish
The Dow is up around 7 percent since the election, closing at record highs, as did the S&P 500 and the Russell 2000. The market run-up almost certainly assures an FMOC interest rate hike for December, if for no other reason than to throw some cold water on markets that are heating up rapidly. It would appear that questions regarding a rate hike must shift from “if” to “how much?”
If the markets have already built in a 25 basis point rise, as many believe, then what happens if the FOMC pushes the Fed Funds rate to 50 or 75 basis points?
Are Hedge Funds Properly Postured?
We will know soon enough. The FOMC meeting is just days away. One thing is certain: Most hedge fund managers will welcome a rate hike. Easy money is considered the principle reason for this, the second longest bull-run since the end of WWII. Hedge funds, especially hedge funds with long/short strategies, suffer the most in a rising market. Such a market provides fewer trading opportunities, which makes it difficult for hedge funds to eke out gains.
One barometer to watch is the global long/short ratio, which represents the ratio of global long and short exposures across all hedge funds and strategies. A high ratio signals a negative outlook, while a low ratio indicates a positive outlook.
For example, Greenlight Capital’s short ratio stood at 1.25 at the close of the third quarter—a very low ratio.
What about the Strong Dollar?
The strength of the dollar is undoubtedly of concern to the FOMC. The strong dollar depresses exports and savages an already troubled manufacturing sector. The incoming administration’s trade policies are also a concern. Of course, the Federal Reserve is completely above politics, or at least this is what they assert in their mission statement. It is possible that the continued strength of the dollar will undercut the FOMC’s plan to hike rates in December.
Other Factors to Consider
Unemployment has fallen to 4.6 percent, well under the FOMC’s threshold defining full employment. The Consumer Price Index pegs inflation at 1.6 percent, which is in close proximity to the Fed’s 2 percent inflation goal and third-quarter GDP growth, has been revised upward to 3.2 percent.
Not only is a rate hike the probable result of the upcoming FOMC meeting, it is possible that the hike will exceed 25 basis points, possibly by 50 basis points. It is also possible that a strengthening dollar will forestall a rate hike entirely. Hopefully, the hedge fund industry is prepared for either outcome.