In the corner of the US interest rate market, which is most in line with Federal Reserve policy, a bet has emerged that will provide a nice profit if traders increase the time they expect the next tightening cycle to begin.
Trading takes place through Eurodollar futures options and has been growing in size over the last week. The increase coincides with opinion polls suggest a growing chance of the White House’s democratic scope and the Congress of Elections on November 3. For many investors, this scenario would pave the way for a significant fiscal spending package, potentially accelerating the economy’s rebound from the pandemic and causing inflation to accelerate towards the Fed’s target.
The focus betting cost about $ 1 million in option bonuses, with a maximum potential gain of about $ 50 million. This will be most profitable if by the next quarter futures have prices equivalent to approximately three increases in interest rates by March 2024, which means that the Fed will tighten at the beginning of the month. By comparison, the euro dollar market does not even reflect full quarter-point growth until June 2024. For its part, the Fed has signaled that it will maintain levels close to zero at least until 2023.
“Forward Eurodollar contracts are affected by where interest rates are in the next year or two – can you safely say that there will not be a big jump in inflation in the next two years?” Said Alex Manzara, a derivatives broker at RJ O’Brien & Associates.
A buyer of this bet option began to appear on October 9, when most purchases were made. The position consists of more than 660,000 options, which raised eyebrows among traders, as well as the stake.
See here for more information on the structure of trade.
The bet created a buzz in a market where activity was declining, in part because the Chicago trading pit was closed for months among the virus. Since the beginning of the year, the daily volume of Eurodollars has exceeded one million contracts in 98 cases, only 10 of which have come since the beginning of May.
$ 50 million shortfall
Potential losses if the bet is not received by the expiration date of March 12, 2021, add attention. The shortfall could reach about $ 50 million if the market moves in the opposite direction, to pricing at a negative Fed rate.
Of course, this is a step that Fed officials have repeatedly said I don’t want to take. And the economic result is hardly preparing for the markets, as stocks are not far below record highs. And further stimulus may come, regardless of the election results.
Click here for more information on what markets expect.
“I will rely on perception,” Manzara said. And the perception now behind buying such a Euro-dollar option structure “is that no matter who wins the election, and even though they failed to agree on an incentive, a big incentive is coming,” he said.
What to watch
- The economic calendar
- October 19: NAHB index of the housing market
- October 20: Building permits; housing begins
- October 21: MBA mortgage applications; Fed Beige Book
- October 22: Weekly unemployment applications; Bloomberg’s economic expectations, consumer comfort; leading index; existing home sales; Manufacturing in Kansas City Fed
- October 23: Markit manufacturing in the US, services, composite PMI
- Fed Calendar:
- October 19: President Jerome Powell participates in an IMF panel on cross-border payments; John Williams of the New York Fed; Vice President Richard Clarida; Neel Kashkari of the Minneapolis Fed; Rafael Bostic of the Atlanta Fed; Patrick Harker of the Philadelphia Fed
- October 20: Deputy Chairman for Supervision Randal Quarles; Charles Evans of the Chicago Fed; Daleep Singh of the New York Fed; Bostic
- October 21: Loretta Mester of the Cleveland Fed; Kashkari; Robert Kaplan of the Dallas Fed; Fed Beige Book
- October 23: Lori Logan of the New York Fed
- Trade calendar:
- October 19: 13-, 26-week bills
- October 20: 119-, 42-day cash management accounts
- October 21: Opening of 20-year bonds
- October 22: 4-, 8-week bills; 5-YEAR TIPS