How some hedge funds would trade a rate cut cycle by Reuters

By Nell Mackenzie

LONDON (Reuters) – While many investors hope that falling interest rates will lead to a soft economic landing, others are forecasting a calm before the storm.

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

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

1/ CONFIDO CAPITAL

* Enhanced income strategies

* Released in 2024

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

Brad Boyd, founder of Confido Capital, said the anticipation of lower rates has fueled high levels of equity and credit prices that are creating a risk asymmetry in the market.

He said he would short any type of risk asset, such as stocks, bonds of companies that may have low-quality balance sheets, real estate or emerging markets. Against this, they would buy credit default swaps, sometimes similar to a form of insurance in the bond markets.

A short position bets that the price of an asset will fall, while a long position bets on an increase.

Instead of picking a specific company, Boyd would take long positions through the index, HY CDX, a basket of credit default swaps or insurance premiums for 100 U.S. high-yield bonds

In the short term, Boyd warned that markets were overpriced for Fed easing and could be hurt if cuts don’t live up to expectations.

“There could be a lot of breaking and crying in the streets,” Boyd said.

2/ MONROE CAPITAL

* Direct loan and alternative lending solutions

* Size: $19.5 billion

* Founded in 2004

* Key Trade: Opportunistic buying in secondary markets

Kyle Asher, managing director and co-head of alternative credit solutions at Monroe Capital (NASDAQ: ), would look to the secondary market to see Fed rate cuts.

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

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

Fed interest rate cuts typically filter down throughout the economy, pushing up the cost of borrowing for businesses and consumers.

“Many of the more mid-sized private companies have loans that trade around 70 to 80 cents, which will see their cash flow increase when the cost of borrowing comes down,” Asher said.

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, Asher added.

3/ ANALOG CENTURY MANAGEMENT

* Technology focused long/short fund

* Size: $1.8 billion

* Founded in 2018

* Manufacturers of long chips for automotive and industrial applications

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

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

“Semiconductor stocks exposed to the industrial and automotive industries have been suffering for some time. Revenues have fallen and technically many have already been in recession for several quarters,” Zlatev said.

If lower 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 share prices of these companies, he says.