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End of market consensus and easy money

The panic selling that hit high-yield bonds, high-yield currencies, and emerging-country debt and equity markets last month has utterly destroyed market consensus.

Investors and traders now divide into two camps: those who feel the markets can effect an orderly unwinding of the global carry trade as the US Federal Reserve proceeds with a measured return to normal monetary policy, and those who see a bubble bursting around us.

This divergence of opinion is a very good thing. Whenever the whole herd of short-term traders and long-term investors comes to agree on one view of markets, they are almost certainly going to be proved wrong. And when they all suddenly surge to escape their ill-judged positions and find no-one to take the other side of their trades, prices gap down and the unfortunate get trampled to death.

We?ve already had a taste of this and a hint, too, of how carefully crafted diversification strategies can break down. In extreme markets, correlation vastly increases. It?s not just long-only players of the reflation trade that are suffering. HFRX hedge fund indices measure returns on eight classes of hedge funds: global macro, convertible arbitrage, relative value arbitrage, distressed securities, event driven, M&A arbitrage, equity hedged and equity market neutral.

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