The ECB’s “insufficient stimulation” for the past years has led to “economies in the region mired in an ugly deleveraging,” a recent Bridgewater Associates second quarter investor letter said.  But “recent policy shifts are unlikely to create a substantial change in conditions in the region.”

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The letter outlined the large hedge fund’s currency and bond market positions, both of which were profitable, and charted the path ahead.

Bridgewate’s moderately short position in global bonds

Bridgewater changed from a neutral to a moderately short position in global bonds in the second quarter, where interest rate trading “generated 2.71% of alpha,” led by the fund’s long position in German bunds relative to other global bond markets. European bond positions benefited from the European Central Bank’s recent announcement that it was engaging in “U.S.-style” quantitative easing.

Bridgewater thinks economic situation in Europe is “too fragile” to withstand a significant interest rate hike, keeping a lid on this trade.  However, the fund thinks the drop in yields over the past months leading up to the ECB’s stimulus announcement “moved current pricing closer to equilibrium.”

The letter said foreign investment is likely to remain weak in the Eurozone as the currency continues to leave regional producers uncompetitive, with foreign investment in the region likely to remain weak.The newly announced euro liquidity plan will only result in limited economic impact. “It has pressured European rates lower and will likely drive European investor demand for higher-yielding assets in the US, UK, and emerging markets.”

Bridgewater plans to remain long German bunds and short the world

Considering the fund’s relative value spread trading, plans are to remain long German bunds and short the world, but Bridgewater has reduced exposure to this position to an extent.  Saying “Euroland remains in an ugly deleveraging,” the letter said the ECB is “many years away” from rate hikes. The fund cut back its exposure after bond markets moved to price in these conditions, with European credit markets now discounting very low rates, even significantly lower than Treasury or gilt yields, the letter noted.

The change in Eurozone interest rates preceded the ECB’s official announcement by months as bond prices in particular, and then later currencies, engaged in strong trending behavior.

In regards to currencies, trading in this sector contributed 1.52 percent to results in the second quarter. The fund’s largest positions in the second quarter were long the British pound and Japanese yen, short the euro and the dollar while long a basket of emerging currency positions.

Bridgewater thinks most emerging currencies continue to be attractive relative to developed world currencies.  In the developed world, the British pound is most attractive, as the UK is ahead of much of Europe in its “healing process.”

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