Traders are creatures of habit, many of them bad and most of them predictable. Policymakers are no different in their proclivities and tend to follow a tried-and-not-all-that-true playbook. Alan Greenspan flooded the money market after the October 1987 crash, cut rates in the early 1990s and did it again just for old times’ sake after the dotcom bust. Ben Bernanke, his successor, one-upped the Maestro in the rate-cutting department and borrowed a page from the Bank of Japan in quantitative easing (QE). He blazed new trails in emergency funding facilities for commercial paper, corporate bonds, money-markets and other markets. It is now left to Janet Yellen to either keep on keeping on or find a way to unwind the combination of zero-interest-rate policies (ZIRP) and QE.
Even though trend-following remains the dominant form of non-high frequency trading, the majority of position traders like to pretend they are contrarians, even if they work in a cubicle. As a result, they believe one of the best reasons to buy/sell anything is it has fallen/risen in price quite recently. Trend-followers have a low opinion of each other’s actions; you are free to sort the implications out for yourself.
This impulse applies to volatility as well. Even though the low volatility environment created by the expansion of global currency swap lines at the end of November 2011 had sound fundamental reasons for continuing, by the middle of 2014 the dominant opinion was it just had to end. How would a rising-volatility environment play out in the Eurodollar market? As sustainable increases in volatility emerge from changes in policies and the macroeconomic environment and not from events those spikes in volatility dissipate quickly. Let’s take a look at the short-term interest rate environment during the 2007-2009 financial crisis and construct a trading strategy accordingly.