Hedge funds faced forced liquidations on euro interest rate swap positions as escalating tensions in Iran triggered a surge in European gas prices, reshaping the yield curve and prompting a reassessment of emerging market bets.
The conflict’s impact on energy markets led to a sharp increase in short-term inflation expectations, causing the 10-year swap rate to rise above the 30-year rate, a phenomenon known as a “bear steepener,” according to a report by Risk.net. This movement triggered stop-loss orders on hedge fund positions that had been betting on the spread between the 10- and 30-year fixed rates on euro interest rate swaps remaining wide.
Over the past three years, hedge funds had largely anticipated that the 10s30s spread would widen, a strategy predicated on expectations of continued low inflation and accommodative monetary policy. The recent spike in gas prices, however, upended this outlook, signaling a potential shift in the European Central Bank’s monetary policy stance and increasing the likelihood of higher interest rates in the near term.
The market reaction comes as investors globally reassess risk in light of the heightened geopolitical instability. Reuters reported that investors are seeking refuge in money market funds as the Iran conflict escalates, indicating a broader flight to safety. Morningstar Canada noted the impact on global stock markets, while UBS highlighted the added geopolitical risks stemming from the US-Iran escalation. Financial Times reported that hedge funds are rethinking emerging market bets in response to the strikes on Iran.
The situation is further complicated by concerns about potential disruptions to oil supplies, which could exacerbate inflationary pressures and further destabilize financial markets. Yahoo Finance reported on a hedge fund raising concerns about the stock of a specific airline, suggesting that the impact of the conflict is being felt across various sectors.
