Eurodollar futures, examples and strategies to trade the interest rate curve

Introduction 

As you know, the Eurodollar futures represent the 3 months interest rate futures. I like the interest rate derivatives because they don’t usually have big movements like indexes, currencies or commodities. Another advantage is that there are a lot of contracts listed on the exchange and you can apply different strategies. The liquidity is very high, unfortunately, it’s not a fast market and getting filled is not easy due to the exchange algo.

We will talk about trading but understanding macroeconomics helps a lot in this kind of products. Let me show you why:

Current Macro view

The U.S. is showing its strength every time they release its macroeconomic indicators. Last week we showed a better than expected GDP growth (3.0%). October has been really good: strong durable good orders (2.2%), better than expected ISM manufacturing PMI, strong services PMI, an increase in Existing Home Sales, 4.2% as an unemployment rate. On the other hand, the Non-Farm Payrolls were worse than the market forecasted due to the effect of the hurricanes. The consumer price index wasn’t as good as the Federal Reserve would like it. But in general terms, the macro data was very good.

Considering all of these facts and a hawkish FED that expects three rate hikes in 2018, the Eurodollar futures should be falling at the moment.

Quick look at the Outrights

 Eurodollar December 2017

     Source: TradingView, Eurodollar Dec17, daily

This is the December 17 contract. It was lower at the beginning of the year because everyone expected a hawkish FED. The USD was really strong at this time. The FED delivered the first rate hike in March and obviously, the interest rate futures fell. After that, this contract rose to set up the maximums of the year in June. This movement was driven by the doubts about how a quick normalization and interest rate hikes could affect the economy. The main concern was the high level of personal debt and how the people could resist and pay in an environment where the interest rates were going up but the salaries were stagnant.  The Fed raised the interest rate in June for the second time of the year, and this contract fell until July. It seemed that everything was going well but the shadow of some geopolitical problems appeared. The front contracts rose. The Fed September meeting was a turning point and the confidence came back to the market. Janet Yellen announced that the Fed will start cutting its balance sheet in October, and she said that the normalization process would be gradual and predictable. At this moment, the sell side was the correct one.

 Eurodollar June 2018

     Source: TradingView, Eurodollar Jun18, daily

The June contract movement has been similar than the December 2017. The main difference is that the Jun18 is trading at the same levels of the beginning of the year, which in my opinion indicates that the market expects that the economy will continue growing in 2018.

 Calendar Spreads

If you think that trading outrights involves a lot of risks maybe you should consider calendar spreads and bet in the yield curve. Basically, you are betting that the difference between two contracts will wide or narrow. You can use technical analysis, macro analysis, quantitative analysis.

Eurodollar December 2017 - March 2018

    Source: TradingView, Eurodollar spread Dec17-Mar18, daily

Looking at the chart, you can see a clear trend that started in September. Does it sound familiar to you? The reason why this spread is going up is that the March 2018 contract has fallen more than the December contract. The economy is performing well, the market expects a rate hike in the beginning of 2018 and 2 more alongside the same year. At the moment, it’s trading at 0.1450, which I consider an important resistance.

Eurodollar March 2018 -  December 2018

      Source: TradingView, Eurodollar spread Mar18-Dec18, daily

This is a 9-month spread. You can see how well the spreads trend. It follows the same pattern as the other outright or strategies mentioned above. It was trending very well in September but it’s moving sideways and showing some weakness at the current levels.

Eurodollar September 2018 – June 2019

     Source: TradingView, Eurodollar Spread Sep18-Jun19, daily

This spread is different. The traders are pricing several interest rate hikes the yield curve is flattening. It has just crossed the 200 EMA and I think this movement will continue.

Eurodollar March  2019 – December 2019

     Source: TradingView, Eurodollar spread Mar19-Dec19, daily

This spread has been falling almost the whole year. The 200 EMA is very significant, every time that the spread closed above it the movement was reversed in a few days. As well as the previous one, it shows weakness.

Butterflies

If you agree that the spreads in 2018 are trending up while the spreads in 2019 are trending down and you would like to trade both, the best thing you can do it´s making a butterfly. This strategy consists of buying one spread and selling another one in which the middle leg is the second leg of the first spread. 

                       Butterfly structure, Step 1 and 2 are the spreads that create the butterfly, own elaboration

You can sell a butterfly if you do with 2 different spreads, you should sell the first one and buy the second one.

Let’s see these butterflies:

     Source: TradingView, Eurodollar Butterfly Mar18-Dec18-Jun19, daily

This is a very volatile butterfly but it’s a good example of this strategy. It supports the theory of buying the 2018 spread (Mar18-Dec18) and selling the 2019 spread (Dec18-Jun19)

     Source: TradingView, Eurodollar Butterfly Jun18-Dec18-Jun19, daily

This is less volatile than the first one. The best aspect is that it ranges all the time.It can rise to the levels drawn on the chart, but there is only my opinion.

Conclusion

I hope that you like. This is only a brief article but I hope that it will help you to understand how this kind of product behaves and the different strategies you can apply. Knowing about macroeconomics helps. I will be promoting this articles on the following twitter account: @fxfincomtrading

Thanks.

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

#trading #eurodollar #macroeconomics #calendarspreads #butterflies #InterestRates #US #Fed

Why is the European Central Bank dovish? Interest Rate strategies

The European Central Bank is very conservative at the time of taking decisions on economic policy. And this fact has been confirmed again today. As expected, the ECB will cut asset purchases to 30 billion euros from 60 billion euros. This will start in January and it will last for nine months to September. One of the reasons why the ECB remained cautious is the weak inflation.

What did the EURUSD?

After the decision, the Euro plunged. 

     Source: TradingView, EURUSD Dec17 Future, 30 min

The market didn’t expect a hawkish decision and it was reflected in the movement of the euro. I started the day falling. You can see how the volumes got bigger around the interest rate decision and the ECB conference. Draghi was optimistic about the eurozone growth but he signaled that is concern about the inflation. Technically, the EURUSD futures has broken 2 important levels (1.1793 and 1.1729)

What is the real reason behind this decision? My opinion

Economics is a social science and predicting the individuals' behaviour is really difficult. Let me make an example to show my thoughts about this dovish decision.

Let’s imagine an ideal world in which the most important economies keep performing like the last couple of years, China’s GDP growth meets the 7%, the commodities keep rising, the Federal Reserve raises rates and makes substantial cuts to the asset purchases and there isn´t any economic shock. In this context, the US dollar will rise vs the euro. The conservative ECB policy will support a weak euro, and with the conditions mentioned, it will help Europe to keep growing and the inflation will peak.

On the other hand, applying the economic policy in Europe is difficult due to the differences between the strong economies and the peripheric economies. So whatever is applied needs to be good in general terms without affecting in a negative way to certain economies.

As a theory, it’s valid but it’s very difficult that all of these will happen.

What can we see in the Euribor futures?

Euribor futures are the interest rate futures in Europe. You will see in the following charts that an improvement of the European economy is not discounted.

Euribor Jun18 future

     Source: Barchart, Euribor Jun18

As you can see it fell at the beginning of this year, showing an improvement of the economy. At this time the inflation was growing and it hit 2% in March. The euro was weak in this period, the EURUSD was trading around 1.06. Since then, the Euribor jun18 has been rising due to the low inflation, the Brexit, the lack of change in the economic policy. Considering the uptrend, the market participants don´t expect changes in the economic policy neither a big improvement of the European economy.

Euribor spreads

Euribor March 18 – June 18

    Source: Barchart, Euribor Mar18-Jun18

Euribor March 18 – December  18

     Source: Barchart, Euribor Mar18-Dec18

These spreads show the same as the outright explained before. A falling spread means that the difference between the two futures is decreasing. Talking about the interest rate curve, we can see that the yield curve is flattening. The main difference between both spreads is the volatility. Obviously, the 9-month spread moves more than the 3-month spread. They are in lows of the year, I would consider buying if I expected an economic improvement. At the moment, I wouldn’t buy because I don’t  see any sign of reversal.

Another strategy to consider is a Euribor butterfly. 

     Source: Barchart, Euribor butterfly Jun18-Sep18-Dec18

The butterfly is in a support and it´s trading at the lows of the year. I think it´s a better choice than the spreads at the moment.

Euribor spread June 18 – June 19

     Source: Barchart, Euribor Jun18-Jun19

The main difference with the other spreads is that the overall trend is bullish. This means that the traders expect that the economy and the inflation will be better in 2019 than 2018. The main problem is that the triangle is one of the most dangerous figures in technical analysis and I wouldn´t trade it until it breaks. If you like interest rate futures you should add to your watchlist. There is a strong support at 0.1550.

Conclusion

First of all, I hope you enjoy this article. The interest rates market is my favourite. You should consider the macroeconomic indicators and follow the central bank meetings. It’s a fundamental market and less volatile than other markets. There are strategies such as spreads and butterflies that are listed at the exchanges so you won’t have execution problems in the different legs. Thanks.

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

#Trading #ECB #Euribor #Euro #EURUSD #fundamentals #InterestRates #Macroeconomics #opinion #Spread #trading #TechnicalAnalysis  #butterfly #creatingValue

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