As fear engulfs financial markets across the world in the wake of US tariff announcements and the resulting stock market declines, despite institutions like the Bank of England expressing concern about an awakening of the basis trade and some reports of hedge funds selling assets to pay margin calls, at this time sources say the catastrophe bond market remains resilient and calm.
Whenever the global financial markets experience stress there can be second-order effects for the catastrophe bond market.Given cat bonds have a functioning secondary marketplace, meaning investors can buy or sell them, while the value of cat bonds is not directly correlated to the influences causing financial market turmoil, they can often be seen as one attractive asset to sell when cash is required, by certain investors.
Any financial market turmoil can raise memories of the global financial crisis in 2008, when some multi-strategy hedge funds opted to sell down their catastrophe bond holdings, seeing them as one of the only assets in their portfolios that could be sold at par values.
So far, sources we’ve spoken with say there has been no evidence of forced selling in the cat bond market this week, despite the continued volatility seen across global financial markets.
Yesterday, financial market observers and analysts began to express concern about the fact US bond yields were rising (implying higher borrowing rates), while at the same its stock markets fell again and the dollar was also down. Today this looks set to continue on all fronts right now, while spread increases in mortgage backed securities markets are being cited as well, another indicator of investor fear it is said.
This morning, the Bank of England put out a financial policy note, in which it highlighted that moves in treasury rates may be due to a reduction in risk appetite among hedge funds that are active in the cash-future basis trade.
These typically levered trades, which amount to hundreds of billions of dollars, are the talk of financial social media today, with some speculating that some hedge funds may be selling assets to build cash positions.
While more broadly the subject of margin calls at some hedge funds has also been raised in the financial press, given the significant drawdowns in many indices are speculated to have created large losses for some.
“Market intelligence suggested that some hedge funds had, in part, de-risked their portfolios ahead of US tariff announcements on 2 April, and so were less impacted by subsequent price volatility,” the Bank of England also said on how multi-strats are reacting to the volatility in markets. “While the margin calls faced by funds following 2 April had been significant, they had so far been able to meet them without taking actions which would further amplify the market volatility.”
In an analyst note put out in the last hour, investment bank Jefferies cautioned on the state of treasuries, saying an intervention from the Fed is possible.
The analysts explained, “Treasury market volatility is intensifying, whether you’re looking at cash, swaps or futures. Liquidity conditions are starting to resemble the Spring 2020 “Dash for Cash”.
“It is not obvious that the Fed needs to step in immediately. Markets are volatile, but so far the selloff in Treasuries has been orderly. The market could find some footing after we get through the 10-year note reopening this afternoon. That said, we do not think we’re too far away from stabilizers coming in.”
Meanwhile, Reuters reported that the, “Unwinding of basis trade reminds investors of 2020 market crash.”
Saying that, “A violent U.S. Treasury selloff, evoking the COVID-era “dash for cash,” has reignited fears of fragility in the world’s biggest bond market.”
Initially investors are said to have dumped equity positions in favour of government bonds, but that as the financial volatility intensified, “Even as equities stayed under pressure, Treasuries were hit by a wave of selling that sent benchmark yields soaring by 17 basis points on the day, while trading within a yield range of about 35 basis points, one of the wildest trading swings for 10-year yields in two decades,” according to Reuters.
Long duration US Treasury yields and UK gilts are both rising again today, with 30-years in both cases causing some concern, while 10 and 5-year yield equivalents also reach highs that have caused analysts to express growing caution over a potential wider fall-out. These bonds and gilts had fallen after the tariffs were announced and the initial market sell-off, but have since been rising as investor concern over their safe-haven status emerges.
We’ve seen in the past how financial market turmoil can cause knock-on effects in catastrophe bonds, from the selling-down of cat bond holdings during the financial crisis, to effects on investor cost-of-capital that flow through into elevated spreads.
Some are saying that rising government bond yields this week reflects their status as a source of cash, some likening them to an ATM for investors. There is also talk of China potentially looking to reduce its US government bond holdings, in reaction to the steep tariffs placed on its economy.
Catastrophe bonds have held steady in price terms, demonstrating their relative lack of correlation once again and continuing to deliver historically attractive yields.
But, given this fact, they are also a potential source of cash at strong valuations for any investors needing to sell.
Speaking with cat bond market participants, we’re told there is currently no evidence of any unusual selling activity, or offers in the market.
It’s important to note that could change and very fast, if financial conditions worsen. But for now it seems the multi-strat investors and hedge funds that have been growing their holdings in the cat bond space are not looking to these assets at this time (again, that could all change, should conditions in the broader markets worsen further, and if it does you could see a very different headline from us another day).
The last year or so has seen a number of large multi-strategy investors and hedge funds becoming far more active in the catastrophe bond market, which has been a welcome source of capital for those seeking reinsurance protection through the cat bond structure.
It’s resulted in more diverse cat bond books being built at issuance by brokers and we’re now seeing large multi-strat investors allocating funds to built-out teams focused on cat bonds and also the wider insurance-linked securities (ILS) marketplace.
For the dedicated ILS investment manager and cat bond fund manager specialists, any sell-off that does occur could present opportunity, so we imagine the community will be watching financial market volatility closely at this time.
Bloomberg reported today that specialist ILS and cat bond manager Fermat Capital Management told its journalists that cat bonds are unlikely to be affected by the tariff turmoil and that the market will continue to deliver attractive returns, catastrophe losses allowing.
That’s down to the relative lack of correlation, of course, which makes cat bonds generally a stable and positive contributor to investors’ portfolio returns at a time of financial market volatility like this.
The main effect on catastrophe bonds and broader ILS instruments of a meaningful worsening of global financial conditions could be in an elevation in the return requirements of investors around the world, as well as in the perceived cost-of-institutional-capital perhaps rising.
But opportunities to buy may also present themselves to the ILS community, should cat bonds get included in any dash for cash by large multi-strategy investors.
However, at this stage (again, we reiterate, this could change), our sources say there’s no evidence of this and the catastrophe bond market remains a stable, relative safe-haven from the financial turmoil at this time.
This stability and calm, alongside resilient performance, can only further drive home the attractiveness of the catastrophe bond market and its relatively uncorrelated return potential.
Also read: Cat bonds stable & resilient amid tariff financial market volatility: Fund managers.
