Imagine for a moment the electric atmosphere of an active Eurodollar futures pit at the Chicago Mercantile Exchange. The date is March 29, 2015 and the time is 12:45 Central and in 15 minutes the Federal Reserve will, in all probability, announce no change in its policy stance. You’re an independent trader making a living by taking a position in three-month Eurodollar futures contracts. The pit has not been active for some time, but traders in person and online all know the day of reckoning is nigh and the Fed will very likely pull the trigger on rates at some point in 2015.
You, like many investors, still believe that the Fed is most likely to make its first move at the June meeting and the data really hasn’t changed all that much so far this year. Having thrived on taking risk throughout your career, you’re long Eurodollar futures heading into the announcement. The position you bought several days ago has, however, turned against you since the moment your order was filled.
And now as the seconds drag into the announcement, your mind is churning and your mettle is being tested. Bond prices have slumped since the February nonfarm payroll reading beat expectations and yields have climbed. You thought you’d catch the falling knife with Eurodollars as implied rates began to price in a premature and now dramatic rise in yields. However, that position suddenly doesn’t look so good and your intention to hold on through the announcement is wavering as the gravity of losses starts to take its toll. At this moment you’d be happy to settle for the smaller loss facing you at the previous night’s close.
Sadly, the above vignette may become a major theme throughout 2015. If my expectations are correct, fixed income traders around the world are likely to become scared of their own shadows as the sun sets on the Fed’s ultra-easy monetary policy. In December Fed Vice Chairman Stanley Fischer noted, “We can’t give precise estimates of dates we don’t know.” Asked whether officials will drop a pledge to keep rates low for a “considerable time,” Fischer said, “It’s clear we were closer to getting rid of that than we were a few months ago.”
The year 2014 proved to be a learning experience for Wall Street analysts who incorrectly projected a return of inflation last year that they thought would prompt the Fed to tighten monetary policy. Rather than watching yields end the year higher, as predicted by the Bloomberg consensus poll of economists a year ago, yields fell across the maturity spectrum (see “Bond bull won’t die,” below).