Eurodollar, looking to the year to date behaviour and the spreads

Introduction

I consider that we should follow the central banks' steps. It´s very useful to adapt your strategies to the economic policy applied and the central bank recommendations. This applies more to investing in a medium to long-term that for day trading. However, it can be interesting to test a trading system with a variable that tracks if the central bank is bullish on the economy or if it has a negative outlook. Today, I will focus on the Eurodollar futures situation.

Outrights

According to the Fed’s positive outlook on the US economy and due to the accelerating growth and rapid job creation, it’s expected that we will see two more interest rate rises this year. With this scenario, the futures should be falling at least  the  next expiries (December 18 and March 19)  

    Eurodollar Dec18, Daily, Source: TradingView

The front-month contract has behaved as expected during the last year. However, the uncertainty about the trade war between US and China has stopped the bearish trend.

    Eurodollar Dec19, Daily, Source: TradingView

This chart is similar to the previous one but this contract is more volatile. 

   Eurodollar Dec20, Daily, Source: TradingView

Again, the volatility is higher for this contract because it expires 1 year later than the previous one.  It closed at 97.06 which implies a lower interest rate than the Dec 19 contract. we will see later how this affects to the interest rate curve.

    Eurodollar Dec21, Daily, Source: TradingView

This contract is more interesting for trading purposes because the daily range his higher and it can offer more opportunities to go in and out.

Comparison

   Comparison Eurodollar Dec18-Dec19-Dec20-Dec21, Daily, Source: TradingView

In this chart, we can see the differences between the 4 contracts showed before. Probably, one of the most interesting aspects of this chart is that the closest expiry shows a smoother price than the other price. This is related with the volatility. At the beginning of the year, the contracts were trading as expected with widen spreads however the trade wars speculation from the middle of May has made the contracts to converge and the spreads have narrowed.

Spreads

    Eurodollar Spread Dec18-Dec19, Daily, Source: TradingView

We can see that that the spread Dec18-Dec19 widened in the first three months of the year and after that, it has been in the range 0.28-0.40. The main resistances for me are 0.38 and 0.40. The highlighted in yellow shows the reversal of the spreads due to the trade wars and the FOMC meeting that showed certain worries about the economy overhitting. The Fed officials didn’t give any indication about how willing they were to speed up the pace of interest rate increases. They weren´t worried about allowing the inflation to rise above 2% for a temporary period as far as the economy would expand. You can see this reversal in the previous charts as the eurodollar futures rallied on these days. 

   Eurodollar Spread Dec19-Dec20, Daily, Source: TradingView

In contrast to the last graph, we can see that the spread has narrowed and this means that the interest rate curve is flattening.  The closing price of -0.02 implies that the 3-month interest rates will be lower in 2020 than in 2019.

   Eurodollar Spread Dec20-Dec21, Daily, Source: TradingView

We can see the same pattern that the Dec19-Dec20 spread has. Again it implies that the 3-month interest rate will be lower in 2021 than in 2020. This can be temporary but in my opinion, it means that the US economy probably will slow down in the medium term. According to the spreads, it should happen in 2019-2020.

Sum up

We have seen some of the Eurodollar futures. We can see that the front months are moving in a different way than the back months. This implies narrow spreads and finally, an interest rate curve flattening. The ongoing uncertainty about the trade wars will continue. As far as the US economic growth continues and the labor data keeps as good as it is, the Fed will keep the interest rate increases expected. Hopefully, the Fed will act independently even if Donald Trump puts pressure to change its monetary policy. I don´t think that the international issues will affect to the US economy at least in the near term, however, we need to keep an eye on Argentina and Turkey. I hope you like it. Thanks.

Have a good trading!!

#trading #interestrates #Fed #inflation #US #macro #economicgrowth #eurodollar #GE #ED #spreads #opinion

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

US Bond and Interest Rate Futures Spreads, US Interest Rate curve inversion

It’s been a while since my last post. I’ve been busy but I will try to write more frequently. Today, I’m going to talk about US interest rates and bonds. In one hand the US economy is performing pretty well, at least for now. The GDP is good but not as the government promised. The employment is strong but the figures show that it’s been driven by part-time jobs and this doesn’t help in the long term. The bank earnings usually reflect the economic performance, and they have reported better than expected profits. On the other hand, the Federal Reserve is tightening. The debt hasn’t been reduced. The protectionism won’t help. This is not new and I believe that you have already read about this.

Fed’s Williams warned earlier this week that the yield curve inversion can be seen as a warning signal. An inverted curve has always been a recession signal.

How can we understand if the curve is flattening or steepening?

Basically, if we simplify the process and we only do the yield difference between 2 different products or the same product with different maturities. If the difference grows over the time, the curve is in a steepening process. If the difference decreases, we will see the curve flattening. Once we understand this we can have a look at different markets:

US Bond Spreads

    5Yr T-Note  - 2Yr T-Note futures spread, Barchart 

In this case, I’ve chosen the price difference between the 5 Yr T-Note and 2Yr T-Note futures. It’s not as intuitive as if I had taken the yields but it’s easy to understand. Obviously, an investor would look for a higher return on a long duration investment than in a short duration investment. If I have 2 assets with a different duration that offer the same return, I will choose the short duration asset. The reason behind this is that I would be able to compound the returns. When there are good news and the economy is doing well, the traders sell the bond futures and considering that the longer duration is more volatile the spread between them will increase. In our case, we can see that the 5Yr-2Yr spread is decreasing.

    10Yr T-Note  - 2Yr T-Note futures spread, Barchart 

The 10-2Yr spread is decreasing and it’s very close to the 8 year low (12.71)

3 month Eurodollar futures

     Eurodollar Sep18-Jun19  spread , Barchart 

This is a 6-month spread in which is going up. You can think that the traders are discounting more interest rate hikes during 2018.

    Eurodollar Jun19-Jun20  spread , Barchart 

This is a bigger spread that covers 12 months. It’s more volatile than the previous one and it´s testing an important support. The most interesting thing is that shows how the interest rate curve is flattening between 2019 and 2020. 

   Eurodollar Jun20-Jun21 spread , Barchart 

If you were surprised with the last chart, take a look at this. Basically, the curve is flat between 2020 and 2021 and probably it will be inverted in the coming weeks or months.

Eurodollar quotes 

     Eurodollar futures quotes, CME

I would like to recommend this short article that offers a different perspective with the same conclusion:

https://www.ft.com/content/f24fbc80-431c-11e8-803a-295c97e6fd0b

Highlights and future questions

All the experts are warning about a possible recession between 2020 and 2022 and as we have seen the curve is inverting at this point. How will the central banks react? Will the Fed choose between fighting inflation or the job market? How will the governments try to reduce the debt? What will happen with the private debt? 

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