Monday, May 11, 2015
Eurodollars and Treasuries Show Bearish But will Succumb to Falling Equity Prices
The Eurodollar futures yield curve has steepened out tremendously today (by 15 bps over the first 5 years). This follows a rare occurrence where the Eurodollar futures open interest actually fell as a result of trade during an employment report session (Friday). Almost always, accounts take note of the new information in the employment report and both longs and shorts, better able to assess conditions, initiate new positions. Instead, for whatever reason, those opposing groups both saw data that caused them to shy away from existing positions (aggregate Eurodollar open interest down 92,000). Because price action was generally constructive or bullish on Friday, we would have to mark the declining open interest as a blemish on the bullish contingency.
Additionally, today’s steepening yield curve would suggest that bearish minded traders are more willing to express themselves out the curve, a sign of greater conviction. We should note that volume is not strong so we might not suggest overconfidence in directionality inferences. However, the above does stack-up to implying a less buoyant front end of the curve.
Finally, last week I noted the decline in the net long positions held by CFTC described ‘non-commercial’ accounts from nearly half a million (a multi-year high –May ’13) over the prior two weeks. These account types further reduced their net long positions by an impressive 122K in the latest reporting week ending Tuesday, May 5. The current 312K in net longs looks stark relative to levels of only a few weeks ago and suggests these account types, often called ‘large spec’ have ‘discovered’ something that has dramatically changed their bias negatively.
I would generally share these convictions and received some additional assurances from the deliberation Fed Chair Yellen had when discussing monetary policy with IMF’s Lagarde when Yellen offered that bond yields “could see a sharp jump” when the Fed raises its benchmark interest rate. For Yellen to have said that leaves me thinking that she may be more anxious to get started on normalizing policy than many believe, despite Q1 growth shortfall.
It is however important that we note also that Yellen pointed out equities as being at lofty levels; “I would highlight that equity-market valuations at this point generally are quite high,”. As such and with heightened concerns myself that the equity market is due a more substantial retreat than was seen last week, I suggest that fixed income prices, Eurodollar futures and Treasuries in particular, but quite possibly Bunds and other sovereign bonds as well may not continue to move toward higher yields over the near term. Instead they may be influenced for a time by a declining equity market in the order of 3-7% from the recent high (S&P). See a series of notes on the S&P and VIX on my blog ‘Diagnostics By Candlelight’