Wednesday, November 26, 2014

EDZ5; Giving Nod to Improving Financial Conditions

It is interesting that EDZ5 has collected nearly twice the volume of any other Eurodollar future today.  Of course EDZ5 is only a step away from where the market is pricing the initiation of policy rate normalization.  It has been some time since the 5th from expiry Eurodollar commanded such a spotlight as it enjoys today.  We might remember that it was the third year out (Greens) that found the majority of attention early in the financial crisis.  After, when it was more widely recognized that things would not be righted so quickly, Blues or the 4th year from expiry was where the predominance of positioning took place – often with super-sized option trades. 

To see the interest roll up the curve is heartening to those who would wish for a more normal financial market backdrop and the Fed seems willing to inch its way there, even while carrying for a long time the baggage of SOMA.  The bleed from maturation will be slow and is expected to begin only after the first policy rate move.  Further afield, we might expect the Fed to use ‘tactical’ sales of the portfolio should some ‘overheating’ become evident.  Otherwise, the balance sheet should be considered a counterweight to any policy rate initiative toward normalization.  At some point prior to reaching what would be considered the longer-run equilibrium funds rate, there is a strong likelihood that the market will price the need for a more forceful policy rate response.      

We still target that for mid-2015 for the first policy rate move and think the Fed might harbor a smidgen of pride to have noted as far back as September 2012 (‘anticipates that exceptionally low levels for the federal funds rate are likely to be warranted at least through mid-2015’) that they would not likely begin raising rates till then.  And while the Fed might not point to it themselves, I would mark such communications as a shining example of ‘visibility’ provided by Fed transparency.

Understanding the lift-off date, a phrase a friend in London dislikes for images such as rocket boosters and stratospheric destinations, and pace of firming is where a good chunk of trade and profitability will come from over the coming years.  Right now, the EDZ5 is saying that the day of reckoning is further out than priced last week and the spread between EDZ5-EDZ6 is saying that the slope of ascent is to be less steep than envisioned a week ago. 

Separately, the EDZ5 and the EDZ5-EDZ6 calendar spread point to likely still rising Eurodollar prices (lower interest rates).  Together, they make me want to ready for a better level to position for a return to pricing Fed lift-off toward June 2015 and for a more aggressively priced pace of accommodation removal.   

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