Bonfire of the CTAs

It’s rough out there, and commodity trading advisors are getting smoked.

Chart via Nomura’s Charlie McElligott:

CTAs — which in practice work a lot like hedge funds — are having the worst two-day run in their index’s history (back to 2000), as bank drama crosses the pond.

In a note today, McElligott says that CTA underperformance is the most “brutal expression” of widespread chaos in markets:

…[It] speaks to risk-management stop-outs and capitulation in both directions, with awful liquidity conditions as market makers / dealers themselves are in “VaR-down” mode with little willingness (or incentization) to facilitate using risk / balance sheet, in light of the jarring PNL environment—particularly within the Rates / Vol space.

It’s a major reversal in fortunes for CTAs, who were the global strategy golden boys last year as inflation surged.

The biggest shock came as CTAs were forced to rapidly deleverage legacy positions on short-term interest rates and eurodollar futures. They covered around $127.7bn in shorts amid expectations that Silicon Valley Bank’s collapse will force the Federal Reserve to capitulate on tightening.

McElligott says that scenario could very well play out, as Credit Suisse’s latest plunge seems likely to exacerbate the stress. After all, breaking the banks is certainly an effective way to put the brakes on economic growth:

If Banks stop working as the transmission mechanism, then the Global Economy is going to get toasted, because these Banks are “at best” going into zombie mode, shrinking balance sheets against the structural headwinds of “lower deposits,” higher Funding costs, tougher regulation, forced capital raises etc—which ultimately means that Credit / Lending doesn’t flow out into the Economy.

Keep those tin hats on, folks.