Europe situation, Euribor, one of the best trades from 2017

Mario Draghi didn’t surprise the market with his speech. He acknowledged a moderation in the pace of the eurozone recovery but he said that it´s early to change the monetary policy. Some analysts believe that the ECB will wait until July to provide forward guidance. I don´t want to speculate but maybe the dovish message was due to the strength of the euro. I would like to remind you that the ECB is buying assets for the value of €30bn a month. The question here is what is going to happen with these markets as soon as the central banks stop these quantitative easing programs.

Euribor Spreads

I will use the Euribor contracts listed in Eurex because I don´t have access to the ones listed on ICE. Sadly these contracts aren´t traded as much as the ones on ICE but they show similar prices. 

     Euribor Jun18-Jun19 spread, source: Barchart

The difference between these contracts is narrowing what indicates a flattening of the Euribor curve. It seems that the current level can act as a support.

     Euribor Jun19-Jun20 spread, source: Barchart

As you can see the curve steepened from September 2017 to March 2018. At the moment is near the support at 0.400. The Jun20-Jun21 spread has the same shape and this is very interesting for me. In the case of the Eurodollar, you can see how the spreads show that the curve is steepening for one period in flattening after 2020. The truth is that the ECB hasn´t changed the policy in the last 8 years and the inflation is still low. Can we see any movement in the outrights?

    Euribor Jun18 futures, source: TradingView

This contract changed the trend one year ago. In my opinion, the European economy looks pretty much the same as 2017.

     Euribor Mar19 futures, source: TradingView

This contract is more volatile but it shows exactly the same movement as the previous one.

Euribor Dec19 futures, source: TradingView

The last 3 charts show how the different futures went up in 2018. What are they discounting? Is the current European economy worse than in 2017? Will we have a global recession in 2020?

One of the best trades

We have briefly seen how the Euribor futures behaved during the last year. As I said the European Central Bank hasn´t changed the economic policy while the Fed has been raising rates for a while. Considering this, the idea was clear: long Euribor futures and short Eurodollar futures.

    Euribor Dec18 – Eurodollar Dec18 Spread, source: TradingView

This trade has been amazing (and I think that it can continue at least for a couple of months) and probably we will read about it in the next “Hedge Fund Market Wizards”.

Sum up

The ECB delivered the words that we expected. Draghi has a difficult job and the protectionism threaten doesn’t help. The Euribor futures are not moving at all, their movements are tied with the European Central Bank forward guidance and the data. The Euribor-Eurodollar spread has been one of the best trades from 2017. It has captured the different economic policy in two economic areas. 

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

Concerns about the US inflation

Yesterday, we saw the FOMC meeting minutes and they delivered what the market expected. They held the rates unchanged and they confirmed that the process of balance sheet normalization will continue. The Fed highlighted the performance of the economy and the low unemployment. It’s true that the US economy is strong and the last GDP reading was better than expected. However, everything is not as the Fed would like it, and FOMC members expressed their concern about the inflation outlook. Let’s see how the markets reacted:

EURUSD December 2017 future

     Source: TradingView, EURUSD Dec17 future, 1 Hour

The Euro has been rising since the beginning of November. If we add to this trend the inflation concerns the result is a weaker dollar. We didn´t see a significant movement, the candle highlighted in yellow shows the upside movement after the FOMC minutes, as you can see the biggest movement was earlier in the morning.

10 Year T-Note December future

     Source: TradingView, 10 Year T-Note  Dec17 future, daily

Everytime that there is a negative outlook the bond futures raise, and this is what the 10Y T Note future did yesterday. I’ve been following for a while this contract and there is a clear triangle that if broken, I believe that it would go up to the resistance at 125.75.

2 Year T-Note December future

    Source: TradingView, 2 Year T-Note  Dec17 future, daily

In contrast with the 10 Year T-Note, the 2 Year T-Note hasn’t swung. The bearish trend is remarkable.

10 Year T-Note - 2 Year T-Note December spread

     Source: TradingView, 10 Year T-Note-2 Year T-Note Dec17 spread, daily

I’ve chosen to spread 1 contract of the 10 Year T-Note future versus 3 contracts of the 2 Year T-Notes. In my opinion is the best spread you can make with these two futures.

Yield between the 10 Year T-Note and the 2 Year T-Note

    Yield between the 10 Year T-Note and the 2 Year T-Note, source: St. Louis Fed

Historically this yield spread is an indicator or the recessions. We can see that it has narrowed during the last 4 years. This indicates the flattening of the interest rate curve.One of the reasons is the improvement of the US economy is pushing the short-term yields higher. The second reason is there is a strong buying pressure in the long maturities that doesn´t allow the yields to go up.

Conclusion

The Federal Open Market Committee statement doesn´t  significantly affect the markets if it delivers what the analysts expected. If it had been hawkish on the inflation outlook, we would have seen a strong bond selloff and buying pressure in the USD. The macro indicators are important but in trading is better to focus on the difference between the figure and the value expected by the market participants. I would use the yield spread introduced in this post for a medium or long-term investment. I will publish a strategy based on the yield spread between the US 10 year bond and the US 2 year bond in the future.

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

Europe strength, UK inflation

We had a lot of data today. Early in the morning, we have seen an outstanding German GDP. The next big announcement was the UK CPI that surprisingly has shown the same reading as the previous one. Followed by this, the German ZEW economic sentiment and the European GDP.At the same time, the central bank governors from the Fed, BCE, BoE, and BoJ were in a communication event hosted by the European Central Bank. Let’s check more in detail what happened with the British Pound and the Euro.

UK inflation data

As I said before, the UK CPI has been released at 9:30. The reading was 3,00%, the same as the September figure. This makes pressure to the Bank of England. Will they raise rates in December? On the other hand, the uncertainty about getting a Brexit deal is growing. If the policymakers don´t reach a deal focused on trade, the British economy will suffer due to the contingency plans from the private companies. In this theoretical scenario, the BoE will be in trouble because the inflation will peak and they have a limited margin to raise the overnight rate due to the high level of debt held by the households. This scenario has a low probability in my opinion.

GBPUSD December 2017 future

     Source: TradingView, GBPUSD Dec 17 futures, daily

Here we can see a bearish trend in the British Pound vs the US Dollar that seems that it’s consolidating and creating a strong resistance around 1.3070. This trend signals the disappointment of the rate rise in the current situation and the uncertainty of Brexit.

     Source: TradingView, GBPUSD Dec 17 futures, 30 min

The reaction of the strong UK CPI has been negative for the GBP in the first two hours after the release. After that, it has recovered. 

    Source: TradingView, GBPUSD Dec 17 futures, daily

The Pound has broken higher while I was writing this post. Head and shoulders confirmed.

European data

Europe has shown its strength with the macroeconomic data today. This morning Germany has released a strong Gross Domestic Product. The GDP (YoY) was in line with the expectations, but the GBP (QoQ) was better than the forecast.

      Source: ZeroHedge, chart taken from Bloomberg

The Geman ZEW economic sentiment was slightly worse than expected, 18.7 vs 20 expected by the analysts. The European GDP growth was in 2.5% and the industrial production 3.3%. These figures confirm the good moment of the European economy.

EURUSD December 2017 future

     Source: TradingView, EURUSD Dec 17, daily

The USD has been raising vs the Euro since September. The European Central Bank has shown its conservative side while the Fed is clearly hawkish. Today the central banks' governors agreed that the economic policy will take part only if the improvement of the economies continues. 

Source: TradingView, EURUSD Dec 17, 30 min

The Euro has rocketed today with the positive data. The strange thing is that we haven’t seen any retracement.

Conclusion

It’s been a good day for the euro but there are some issues to resolve. The main concern is the European inflation is not as high as the BCE would like it. The strengthening of the euro can lead to keeping the inflation low and Draghi knows about it. In the other side, the Bank of England is raising rates in order to fight the inflation.  This is not well seen by the market participants due to the Brexit uncertainty. In the other side of the Atlantic, Janet Yellen confirmed that the Fed will raise rates according to the economic improvement. Working nowadays in a central bank is not easy, considering that they need to be careful with their language, prepare the markets to avoid repercussions on the real economy and guide consumers about the expected outlook. All of these things shouldn't affect your trading but I think macroeconomics is helpful at least to understand the big movements.
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