Thursday, January 9, 2014

Fed Policy Liftoff Concerns Signaled by Green Eurodollar

The Eurodollar Green Pack was traded heavily yesterday both in futures and option and we noted here the potential importance of this development in terms of market participants looking nearer out the yield curve to position for Fed Policy Liftoff.  The inevitable result of normalization of monetary policy from extreme accommodation to lesser amounts of accommodation and eventually removal of such arguably involves many stages and the Fed would like all to believe there is little connection between a tapering of securities purchases in its QE program and the implication for ‘zero interest rate policy’ (zirp) liftoff date. 

However, the connection is clear in that any positive development prompt for the Fed in a reduction in additional accommodation (taper), while clearly not tightening, is a step toward normalization and this as well as policy rate liftoff would be considered only when improving economic conditions exist.  Arguably and given emphasis in the last two FOMC meeting minutes the Fed has some concern for the efficacy of the purchase program and would, for reasons of declining benefit, like to eliminate this program in a timely manner. 

Recently stronger economic data in higher than expected Q3 GDP, stronger Trade Balance numbers and improved employment, production and spending levels point to gained economic traction and lessen concerns that the Fed is simply removing the asset purchase program because it is not working and will look to replace hoped-for support by other means.  In the absence of expectations for newly supportive supplementary policy tool usage, economic agents cannot be blamed for stepping up their interest in the liftoff date for policy rates…even if these expectations are not immediately nearer in time than previously understood. 

The risk for adjustments in pricing the liftoff date for monetary policy normalization through higher fed funds rates is increased with greater traction in economic growth, a situation which has been lacking for too many years. 

Looking again at the Green Eurodollar Pack (March ’16-Dec ’16), we note that weaker prices in this sector outpaced those of the surrounding Red and Blue Packs years.  As it is, the Red/Green/Blue Pack butterfly trades to a positive 11 basis points, a level not seen since mid-2011.  We should note also that open interest was higher by 71,000 in the Eurodollar strip as a result of trade yesterday, supporting the direction of trade.  Specifically, the Green Pack found open interest higher by roughly 12,000 in net as result of trade yesterday.

For guide, weakness in the Green Pack is consistent with my belief that the Fed will be required to rely more heavily on the policy rate hikes to support a move toward normalized monetary policy as expectations for the Fed to hold to maturity its purchased securities is realized. This too is the reason we should expect even greater flattening in the Treasury 5-30 yield curve.

Marty McGuire

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