Eurodollar spreads gauge taper decision

Yesterday and today there has been some buying of the EDZ6-EDM8 calendar spread.  An additional  5,000 spreads were bought today at 127 basis points adds to roughly 15,000 bought yesterday between 126 and 127. This spread traded to a high of 155.5 on Dec. 18, the day of the December FOMC meeting where the Fed announced monthly securities purchase taper plans in ‘measured steps’ of $10B per meeting reductions.

Open interest data are not conclusive as to the nature of the positioning. Open interest in EDZ6 decreased by 15,000 as a result of yesterday’s trade while EDM8 open interest increased by 5,000. Clearly however, the activity in this spread was greater than usual and deserves some attention.

After trading to a high of 155.5 basis points on FOMC Date, Dec. 18, EDZ6-EDM8 last Thursday traded to a six-month low of 123.5, but held, at settle, the recent Jan. 22, 125 bp-low.  It may be that an account with a short position (flattening trade) on this spread chose, after seeing the recent six-month low hold, to remove the trade.  Conversely, having held support following a multi-month flattening, the account may be looking for the Fed today to provide reason to expect greater tightening of monetary policy over that period.

There should be 12 FOMC meetings between December 2016 and June 2018. At 127 bps, the market is pricing roughly 10.6 bps of tightening per meeting over this period.

A downward sloping trend line dating from Dec 18 would intersect trade today at 130 bps. The 123.5-125 level below should be considered support.  In short, this spread is poised for a break-out.  A break-out to the upside would imply a more aggressive Fed move toward normalizing policy rates. The other suggests the Fed will maintain extreme accommodation for a very long time.

About the Author

Martin McGuire, managing director at TJM Institutional Services

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