Thursday, September 4, 2014

ED & TY; Enjoy Pre-Payroll Price Swings, But Only Marry ‘Significant’ Move

We should not expect a runaway bid to form in Eurodollars or Treasuries…but we should respect implications should that happen.  A generous Chief Economic friends from a shop I used to work at is kind enough to share some of their fantastic research and a piece that passed my desk recently spoke of a normalizing of the reaction function of treasury pricing to the differential between the expected and actual payroll events. 

I have for years followed the reaction between expected and actual payroll events and have used historic data provided by Ray Stone (Stone & McCarthy Research Associates) years ago as well as additionally collected data series to help model expected post-payroll price action.  In general, my model attempts to project price action in the Eurodollar futures strip based on the differential between actual and consensus non-farm payroll results.  Following the financial crisis, the reliability of the model results suffered as monetary policy expectations ruled supreme. 

The dynamics for pricing post-payroll price action based on differential between consensus and actual may be returning toward historic reference as the economy transitions nearer to full employment.  It shall be interesting to see if the reaction function becomes increasingly predictable as the output gap closes.  There has not been enough data to have any strong confidence at this stage that pre-crisis patterns will re-emerge.    

One of the more striking conclusions in my research on the price action of Eurodollar futures around the ‘payroll event’ is the tendency to see price action consolidate in front of the report.  Specifically, there is a historic tendency for Eurodollar prices to consolidate in the two sessions prior to the employment report.  The consolidation I refer to is the differential between opening and closing prices on those two sessions (Wednesday and Thursday) before the report.  In general, those differentials between open and close on the two sessions prior to the employment report tend to be smaller than average, pointing I believe, to the importance attached to the payroll event.  Simply put, the information provided in the sessions prior to the employment report pale in comparison to the implications of the employment data and thus is considered ‘noise’.  The market instead awaits what if feels is important and market moving data.   

Further, the instances where price action is found to have moved ‘significantly’ from the opening level to close, indicates market participants have found some data they feel supersedes the importance of the payroll event and have thus already made up their collective mind on how price action shall follow.  In such instances, historic data point toward a likely follow through of that sentiment after the employment report release. 
As such, my message today is enjoy the vacillation in Eurodollar and Treasury prices, take advantage of any nominal price swings by fading that move.  But respect the implications of a ‘significant’ price adjustment today and if that unexpected outcome happens, expect a knock-on impact to any payroll print tomorrow. 

As I was writing this note I watched TYZ move from 125-17 back to the opening level of 125-10 and EDU5 relinquish 2.5 bps of gains following the release of ADP, Claims and Productivity data. 

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