Hedge funds unwind over rate blues

Worries about higher interest rates triggering a fall in global financial markets finally seems to be coming true.

The fall in metal prices on the London Metals Exchange (LME) and the subsequent volatility in emerging equity markets were largely a result of unwinding of positions by some hedge funds, which were operating on huge yen-denominated borrowings.

The selloff over the past few days was ignited by indications that the Bank of Japan would raise rates going forward, dealers from leading foreign broking houses said on Tuesday.

"Some hedge funds have been selling big time as their cost of funds would increase if the Japanese interest rate rise," said Amitabh Chakraborty, head of research, privileged clients group, Brics Securities.

Markets have been somewhat weak since last week after the Fed hiked rates further indicating that further rate hikes can't be ruled out.

"Markets were expecting that the Fed would not hike rates beyond 5 per cent. But indications by the Fed chief that the further rate hikes would be linked to the economic data flow going forward had made market players nervous" added Chakraborty. Fears of rate hike by other central banks has also added to the nervousness.

"Thus far a number of long-only hedge funds were busy booking profits as valuations looked stretched. But now they have been replaced by momentum funds which are rising on the weak sentiment" said Naresh Kothari, head of sales, Edelweiss Securities.

Last week, five-year yields had surged to their highest levels since 2000, on speculation the central bank was readying to hike rates next month once it meets its reserve target.