Monday, August 18, 2014
U.S. Rate Prospect; 'The Big Short Squeeze'...finally?
The ‘Big Squeeze’ in Eurodollar (futures and options) has been forecasted many times since mid-2013 when the steady rise in net short positions held by CFTC described ‘non-commercial’ accounts began. Quite a few traders have lost money over the last year positioning for a reversal of these holdings. Within the last several weeks, there have been two separate reductions to net short positions held by this account classification – often referred to as ‘large spec’ accounts. It had been since April 2013 since as large a move toward lesser short positions had been seen and now we have seen two such instances within the last 5 weeks.
Interestingly, we have heard very little lately of the prospects for a short covering event from this account class despite fairly large price gains in Eurodollars and Treasuries over the last two weeks. The reason for this may be that the bullish advance in Eurodollars and Treasuries has been interpreted as having had more to do with elevated geopolitical developments than specifically weak domestic economic readings or some other variable.
Our interpretation has been that heightened disquiet and a lack of consensus within the FOMC have reduced the visibility for Fed monetary policy intent. Long a source for stability in a struggling economy, a protracted forward guidance for policy intent has tended to reduce volatility around unexpected economic and geopolitical happenings. The absence of this longer timeframe guidance brings heightened volatility that cannot be satisfied by reduced geopolitical turmoil or more tempered trend economic growth. Instead, even at a potential ‘break-out’ level of economic growth and financial stability, the need for greater certainty by economic agents surrounding longer time frame for monetary policy intent is itself a deterrent from a willingness to engage in new production, investments and spending.
Of course if the above is correct, the upshot for Eurodollar and Treasury futures is bullish and has the chance of catching some ‘non-commercial’ (large spec) accounts holding too great a short position in Eurodollars. As noted in recent writings, developments this past year as regards interruptions from and reacquisition to 2-2.25% trend line growth has possibly set for conditions that bring about another in a series of late 3rd quarter-early 4th quarter cyclical yield lows (for 10 year Treasury Notes). If so, there are likely further gains in Eurodollar and Treasury futures and still greater prospects for a short covering event.
This week, the Fed and other global central bank figures meet in Jackson Hole for an annual confab that has been a staging event for a number of new stimulus programs announced over the last years. This year no such expectation for a new round of stimulus is held, but some expect to be provided additional clarity in Fed monetary policy intent. If Fed policy intent is not clarified to satisfaction, there is room for additional volatility on the back of these failed expectations.
Therein lays the risk that is real for today’s rates market. The border between Ukraine and Russia shall become more or less delineated and Gaza Strip will be a more or less violent place to live, but economic agents and traders of short and long U.S. domestic rates await greater clarity on an extended timeframe for Fed monetary policy intent. Absent this, we should expect higher volatility, weaker current economic conditions and lower baseline yields.