ECB is at front of mistakes queue - and here's how to profit

The European Central Bank (ECB) is leading the charge when it comes to policy mistakes as it faces the ‘impossible task’ of determining monetary policy for 17 diverse economies, Ignis’ Russ Oxley warned.

The firm’s head of rates said the ECB’s decision to hike interest rates last year was wrong and that this mistake could be repeated again in the summer, although it would throw up a number of strategic and profitable trading opportunities.

As a result of this, Oxley’s Absolute Return Government Bond fund took an underweight in three and two-year bund forwards against an overweight of five-year bunds.

The manager said the markets last year found that a lack of any coordinated response within the eurozone was worrying, which helped the fund benefit from its view there is a shortage of safe-haven assets.

In this sense, the fund benefited from over-weight positions in three-year and two-year forward gilts and switched into a similar position in bunds.

Oxley said: ‘S&P's decision to downgrade US sovereign credit rating to AA+ heightened concern over the shortage of safe-haven assets (US is 50% of global triple AAA assets).

‘These concerns translated into excessive levels of interest rate volatility. The fund sold volatility to take advantage of our belief that the US was still a safe haven and the resulting central bank response – commitment to keep the Fed funds rate at record lows until mid-2013 at the earliest – saw volatility fall rapidly in the remainder of the year,’ he added.

Prior to Operation Twist last September, the fund had already benefited from taking long-dated treasury forwards.

The fund also shorted core European bond markets against safe-haven AAA countries on the basis of the peripheral eurozone’s deterioration.

Going long UK three-year and two-year gilts last year gave the fund a profit of 150 basis points, while going long five-year and 10-year US treasuries delivered the fund 45 basis points.