How the main futures reacted to the Non-Farm Payrolls, US wage growth and US unemployment rate

Introduction

The Non-Farm Payrolls is one of the most important macroeconomic releases of the month. According to my master’s dissertation, it’s the macroeconomic release that has the biggest effect on the markets.

If we look back 10 years, we can conclude that the biggest impact in the markets has been made by the monetary policy applied by the different central banks around the world.

The Figure

I expected a lower figure like the most part of Wall Street analyst… To my surprise, the US added 201000 jobs in August. The previous figure was 157000, so we saw an important increase. The unemployment rate was unchanged at 3.9%. Probably the most important release of the day was the US wage growth. It showed 2.9 % which is a level that we hadn´t seen since 2009. The US economy keeps pushing and probably we will see another rate hike in the next month. Considering this good news we should expect a sell-off on the fixed income futures.

Eurodollar

    Eurodollar Dec18 futures, 15 min, source: TradingView

The positive surprise on the US wage growth and the US Non-Farm Payrolls create an opportunity to sell for the traders.  Maybe you think that 7 ticks are not enough but considering the nature of this product is a big change. You can compare the daily range from the previous days in the chart above.

Fed Funds

    Fed Funds Jan19 futures, 15 min, source: TradingView

The traders reacted in the same way as the case of Eurodollars. It took this future to the previous support at 97.65. Considering the upcoming rise in the US interest rates, I expect this future to keep falling.

10Y T-Note, 5Y T-Note and 2Y T-Note futures

We saw a strong sell-off in the US bond futures. The main difference between them is the range of the movement. Obviously, the longer the duration, the bigger the volatility and the movement range as we can see in the following charts.

   10 Year T-Note Dec18 futures, 15 min, source: TradingView

The 10 Year T-Note Dec18 futures fell 49 ticks. It broke the previous support.

    5 Year T-Note Dec18 futures, 15 min, source: TradingView

Even if the chart seems similar, the 5 Year T-Note Dec18 fell 32 ticks.

    2 Year T-Note Dec18 futures, 15 min, source: TradingView

It fell 11 ticks and again we can see an important move.

An alternative

The main problem of trading the Non-Farm Payrolls is that the liquidity disappears just before the data is released. There is the possibility to execute at a bad price if we enter a market order.  Another problem is that you shouldn’t place a stop loss near the limit order because probably it will be triggered.

The alternative of trading the outrights would be trading spreads. The advantage is that we can trade a bigger position than in the outrights because we are hedged (or at least in part). If we take the spread between the 10 Year T-Note and the 5 Year T-Note at the ratio of 1-1, we can see that movement was only 17 ticks. If we decide to trade this spread and considering positive news for the US economy, we should sell the future that represents the future with longer duration and buy the other one.

Summary

We have seen how a macroeconomic release can affect the markets and how the traders interpret the data and execute the trades.  Nowadays, at least 70% of all the trades are executed by automatic trading systems and they are quicker than the point an click traders so making a profit in this kind of releases is getting really difficult. The only possibility would be position yourself with a small size in the right side of the trade and with a reasonable stop loss. If you don´t want to trade the outright, you can trade the spread. In this case, you need to make sure that you make enough ticks to cover the commission because you have double commissions. I hope you like it.

Have a good trading!!

Disclaimer

I wrote this article myself, and it expresses my own opinions that shouldn't be used as a trading advice. Trading carries considerable risk due to the high leverage involved

Fed Funds vs Eurodollars futures

The interest rate markets offer a lot of possibilities and strategies. You can trade the outright, the intra-product spread (calendar spread or calendar spreads combinations) and you can create your own spread with different futures (inter-product spread) Sometimes I analyze the outrights and certain spreads but today I’m going to introduce a strategy used by some of the biggest market participants. 

      CME Interest Rate Products, source CME

The spread

I’m not going to focus on the back of the curve. The products to make this strategy are Eurodollar futures and Fed Fund futures. Before I explain the strategy lets define these products:

• Eurodollar futures are based on a 3 month LIBOR.
• Fed Funds futures are based on the average daily effective Fed Funds rate and calculated the last business day

Considering the different  value per basis point we need to calculate the spread ratio:

Spread ratio, own elaboration                                                  

In order to get the ratio, we should divide the Eurodollar value per basis point by the Fed Fund value per basis point. In our case, we will trade 10 Eurodollar contracts and 6 Fed Funds contracts. Considering the forward-looking aspect of Eurodollar futures, the Sep contract will cover from September to December. We need to choose 2 different Fed Fund contracts between these maturities, in the example October and November.

Spread calculation in basis points, own elaboration                 

In the example, the spread in basis points has been calculated as (Fed Funds average price – Eurodollar price) *100

    Eurodollar-Fed Funds spread, source TradingView

What and why are we trading on this spread? Basically, we are betting that the spread between these 2 products will narrow or wide in the future. Having in mind that the eurodollar is based in 3-month commercial loans will be more volatile (for the duration and the credit risk) than the Fed Funds (1-month loan between banks insideUnited States)

We can use this spread to bet that the interest rate curve will change. Let’s say that if there was a high probability of an interest rate hike, I would position myself short Eurodollars and long Fed Funds.

          Fed Funds Rate, source TradingEconomics

If you compare this chart with the previous one, you can see why you need to be right and always taking the direction of the market with the Eurodollar contracts.

Sum up

I hope you like this brief introduction. This spread will allow you to diversify the strategies. There are 2 main risks: taking the wrong side of the position and the execution risk. The second one is obvious because there are 2 different products on this strategy.  It´s easier to make a calendar spread because you can find them listed on the exchange. 

Have a good trading!!

Disclaimer

I wrote this article myself, and it expresses my own opinions that shouldn't be used as a trading advice. Trading carries considerable risk due to the high leverage involved

Fed Funds futures, different trading strategies

Today I´m going to focus on the trading piece. I will explain the Fed Funds, the futures characteristics, the different trading strategies that you can use. If you are experienced in trading, you can jump to the third section.

What is the Fed Funds Rate definition?

The interest rate at which a depository institution lends funds to another depository institution overnight. These funds are maintained at the Federal Reserve.  As soon as the federal fund rate rises, borrowing becomes more expensive. You can consider these rates as the base rate that determines the price and the structure of the interest rate curve.

What are the characteristics of the Fed funds futures?

The futures contract has a face value of $5000000 for one month. This means that every time that you take a 1 lot position, you need to deposit $400 (this is an example) margin but it’s like you were trading $5M. The price quotation is 100 minus the average daily fed funds overnight rate for the delivery month.

 Example: Fed Funds overnight rate = 3.25, so the Fed Fund futures will be 100– 3.25=96.75

They have a monthly expiration. The tick value depends on the month we are looking at. If it's the nearest expiring month contract the tick value is $10.4175 because it´s quoted in ¼ of the interest rate basis point. The rest of the contracts are quoted in ½ of the interest rate basis point, so the tick value is $20.83 There are 36 months listed at the exchange.

This is the link to the contract specifications on CME:

http://www.cmegroup.com/trading/interest-rates/stir/30-day-federal-fund_contract_specifications.html

You can check the margins as well. Please be aware that they can be different from the ones that your brokerage offers.

Why should we trade them?

They are stable and they don't have big daily changes, there is a lot of liquidity. You should be careful because there are important days in which they can move a lot If you don´t feel comfortable it´s better to be out of the market in FOMC meetings, and economic releases such as GDP, Unemployment rate, CPI, Industrial Production and Retail Sales.

How to trade the Fed Funds futures?

You can trade them based on economic fundamentals, technical analysis, and quantitative models. Let me start on economic fundamentals, if you see the macroeconomic fundamentals are improving, you can think that the Fed funds rate will rise so you need to sell the futures (remember the quotation, 100 minus the average daily fed funds overnight rate). If you think that the economy will deteriorate, you should buy the futures. Please do not follow these simple steps because you should consider more things before you decide to trade.

If you prefer to base your decision on technical analysis you know that you should look for trends, important levels (such as resistances and supports), the market profile provides these levels with the volume traded on them. 

    Source: TradingView, Fed Funds Dec17 Futures, daily

As you can see, it moves as the 3 month Eurodollar futures. It closed higher last week due to the FOMC meeting, lower than expected US CPI and US retail sales.

    Source: TradingView, Fed Funds Dec18 Futures, daily

This is the Dec18 contract. It’s more directional and the range is bigger than the Dec17. One of the differences between both contracts is that Dec 18 broke the support in 98.39 while the Dec 17 couldn´t even test the support made in July. This means that the traders expect more interest rate hikes in the following year.

Alternative strategies

If you don’t like to take excessive risk with the outrights you can do spreads or combination of spreads such as butterflies or condors. Let me summarize advantages and disadvantages.

Advantages:

• You take less risk
• You can hold the position more time
• The margin is lower than the outright
• The Fed funds spreads and butterflies are an Exchange traded contract, so you don´t need a specific functionality in your trading platform

Disadvantages:

• Your trading fees are bigger
• It moves slower than other instruments

Fed Funds Spread Dec17-Dec18 

    Source: TradingView, Fed Funds  Spread Dec17-Dec18, daily

This chart seems that is one of the above reverted, this is why it shows the differences between the Dec17 contract and the Dec18. If we compare all the charts above and this one, the last two months rounded in red, the Dec18 fell more than the Dec 17, which means that the spread is bigger between both contracts.

Fed Funds Butterfly, Dec17-Jun18-Dec18

    Source: TradingView, Fed Funds  Butterfly Dec17-Jun18-Dec18, daily

The butterfly is made up of three equidistant maturity outrights within the same product, so it contains 3 legs You need to buy the same amount of contracts in the first and third leg, and sell double of the contracts used in leg 1 in the second leg. The chart shows the following combination

                                                    +1 Dec 17 -2 Jun18 +1 Dec18

As you can see this product was in a range until September, and it’s been rising since then. This means that probably the traders expect an interest rate hike before Jun18.

I hope you enjoy this post. There are a lot of trading styles. You need to look for the one you feel comfortable with. 

Have a good trading!

Disclaimer

I wrote this article myself, and it expresses my own opinions that shouldn't be used as a trading advice. Trading carries considerable risk due to the high leverages involved