Tuesday, June 3, 2014

Green – Blue Eurodollar Pack Spread Seller; Bull or Bear Positioning?

Today we hear of a dealer selling Green Packs to buy Blue Packs as a spread (1k at +1 on the day, Greens over).  The question I pose is one many continue to ask regarding this part of the yield curve.  Over the last 6-9 months, traders have been gravitating toward the greens as representative of the focal point for Fed rate action.  Before then, we were quite accustomed to seeing the Blue Eurodollars as collecting much more future and option flow.  This is consistent with the passage of time and the steady nature of market expectation for Fed ‘normalization’ of monetary policy activities to commence toward mid to late-2015.  Of course we care not only of the ‘lift-off’ date but also the ‘steepness’ of policy intent.  Less disagreement of late has centered on the timing of lift-off as to the steepness of policy ascent and this ‘centering of debate’ is unlikely to change anytime soon.  This leaves the Greens increasing vulnerable to pricing greater or lesser ‘steepness’ (of policy rate ascent) over the coming few months.     


A seller of Greens today against the Blues will benefit from continued expectations that the Fed will begin removing liquidity by raising policy rates before late-2015 or early-2016.  If these expectations remain then widely held understanding for terminal values of equilibrium long-run real GDP suggest the Fed should be able to complete ‘normalization’ (as currently understood) prior to mid-2017. 


I show a weekly chart of the rolling Green-Blue pack spread dating back to 2001.  Take note of how the spread fell 100 basis points from a March ’04 high of 107 basis points to the late-Feb 2006 low of 7 basis points.  The timing of that move was centered around the approach and culmination of the last ‘accommodation removal’.  If we recognize the beginning of the Fed tapering of securities purchases in January of this year as consistent with the ’04 lift in policy rates, we might expect the late-December 2013 spread between Green-Blue pack spread of 108 bps as consistent with the early ’04 high and project a continued flattening in this part of the curve by another 75 bps over the next year or so.  

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