Looking at the final few weeks of 2025, James Athey, fixed income fund manager at Malborough, discusses the biggest influences of fixed income liquidity, including the US Federal Reserve’s end to its quantitative tightening program in December and the impact of year-end de-risking strategies.
Athey also shares his views on the concerns surrounding the private credit markets, the AI-related debt risks in the electricity sector, and potential market volatility from delayed US economic data.
Interview
Jo Gallagher – So the Fed is set to wrap up its quantitative tightening program in December, with that event included. What are some of the big themes and factors that will influence fixed income liquidity as we come into your end?
James Athey – Yeah, quantitative tightening and its end are definitely a big one. You know, the Fed’s been reducing the size of its balance sheet for a few years now. Of course, that means running off the securities holdings, which has the effect of sucking liquidity out of the market. That’s been a sort of constant headwind for fixed income investors, particularly in Treasuries and mortgage-backed securities. So of course, that process coming to an end potentially means that that headwind becomes a tailwind. So that’s good news on the face of it for bond investors. Assets in general tend to perform better when liquidity is being injected, so investors will be looking at this as a tailwind for all assets as we move into next year. Why are they doing this? Well, we’re just starting to see some of those stresses emerging in front-end funding rates that suggest reserves have gone from excess to ample, to use the Fed’s terminology. So they’ve announced that they believe we’re close, and so they’re going to, as you say, finish their quantitative tightening program in December. That process will certainly help secondary-market liquidity. It’s not going to be a massive change, though. But I think as we look into December, what’s more likely to be impactful is just that traditional process that we see into year-end, where hedge funds in particular, asset managers in general, just look to de-risk ahead of the holiday season, to take profit on those profitable positions, protect their P and L for the year. And of course, that can see some slightly strange moves in markets but it also starts to really affect secondary market liquidity as we move into December,
Jo Gallagher – Turning to the private credit market, I’ve had some very divided opinions. How concerned are you about this space, and how widespread are the risks?
James Athey – Yeah, I always think it’s important to pay attention to who you’re hearing from, because obviously folks who are invested heavily in this stuff are not really incentivized to point out that there are significant problems. And we know from history that even when we do have systemic risk-off events and systemic credit problems, they generally start with just one or two stories that don’t seem to be linked in any way, before we find out later that actually there is some common underlying cause. Clearly in private credit markets, there’s just a lot less transparency. There do seem to have been also some rather nefarious behaviors going on. You know, I quite like the quote from Jim Chanos from a few years ago that we’ve been living in the golden age of fraud because, as he sees it, and I would agree, when you just have so much liquidity out there, so much desperately chasing return, it tends to be the case that people stop doing their due diligence. In fact, there was a quote from a private credit manager in the FT just a few weeks ago saying, this is a market where you’re not being paid to do due diligence. So for credit investors such as myself in public markets, you look at that and you do start to think that you should be a little bit concerned, a little bit cautious. So certainly that’s how we’ve been viewing the problem and looking really to de-risk our credit holdings somewhat, just given how tight spreads are and how little excess return there seems to be left,
Jo Gallagher – How are you adapting your portfolio as you come into your end, and how much of a role do credit derivatives play in your investment strategies?
James Athey – We don’t actually use credit derivatives ourselves in the portfolio currently, but they are a quick and ready way of hedging overall credit risk. They’re highly liquid, and it means that you can significantly reduce credit exposure in a very short space of time. Generally speaking, I think they’re better suited to tactical hedging. You know, when it comes to the big moves, the big cyclical effect on credit spreads, we would much prefer to ensure that our cash holdings, our credit beta, you know, how much we’re exposed to spread moves in general, is appropriate given valuations and given our assessment of the cycle. So with spreads very close to the tights for the cycle, you know, as tight as they’ve been really in decades, on the face of it, you’re not being compensated hugely for taking credit risk. And our assessment is that we are in a late cycle phase, and that means generally slowing growth, rising unemployment, and a less friendly environment for investors in risky assets, and credit in particular. So we’ve been significantly reducing our credit beta to account for that. There are other things that we have been doing as well. You know, for example, we’ve significantly reduced our exposure to the electricity sector. Now this has been a big beneficiary of the whole AI-powered generation story. The problem for us as credit investors is that these electricity companies are most likely to be the ones taking on lots of debt today on the hope that this AI build out is going to be hugely successful, and if it is successful, as a credit investor, you don’t participate in the upside, so you get a lot of the risk of stranded assets without the potential for huge profits if the AI transition proves to be successful. So sectorally, looking defensively, making sure, from a macro perspective, we’re happy with those exposures, but most importantly, significantly reducing our credit beta.
Jo Gallagher – And finally, what else needs to be on trading desks’ radar for the end of the year?
James Athey – As I mentioned before, the normal approach to year end is to consider the de-risking trade. It started really as a hedge fund trade, but I think more broadly now, asset managers all engage in this kind of calendar year management. Banking sector as well has to manage their balance sheets ahead of big regulatory deadlines at the end of the year. So hedge funds reducing significant leverage positions. Asset managers also looking to take chips off the table, and banks really not being as willing to provide balance sheets to facilitate these trades. So of course, that means generally reduced secondary market liquidity. It probably means higher volatility, and it probably means as well that a lot of the trades that have done well are likely to face headwinds and start performing very differently as large groups of investors who’ve all got the same positions on reduce those positions together. So that’s definitely one that we always look out for. Try and make sure that you’re not still in any highly consensus trades, particularly any which are of lower liquidity. Connected to that, but also just to the AI question in general, we started to just see equity volatility pick up a little. We’ve had some decent-sized down days. That kind of chorus of voices who are openly questioning valuation in the AI sector, how quickly this can become profitable, where those revenues are going to come from. That’s really started to weigh on some of these really incredibly expensive stocks, and I think that’s likely to continue as those two dynamics combine with one another. I guess, finally, and it’s definitely significant, is the lack of US economic data that we’ve been living with for the last month because of the US government shutdown, we’ve been feeling around in the dark to a significant degree. It seems likely that in the coming weeks, that shutdown standoff will be resolved one way or another, and as the government reopens, we will get this flood of economic data, some of which will possibly have been produced with less data, with a lot of statistical methods, its reliability will be questioned and questionable, and so a huge dump of potentially distorted data covering a very long period of time, you know that really has the potential, again, to inject volatility during a period where volatility is likely to be higher, liquidity is likely to be lower than normal. So that’s again, another one that we’re definitely focused on.
Jo Gallagher – Thank you, James, for your insight, and of course, you for watching this has been Trader TV This Week.
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