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Trading Eurodollars after a 75bp cut...

28 January 2008

The Macro Trader’s view:
We have been bullish of Eurodollars for some time and enjoyed much of the recent rally, but earlier this week we closed our position in Dec 08 with a very healthy profit; just before the Feds emergency 75bp rate cut.

With equity markets selling off globally, the markets were awash with rumours of an emergency coordinated rate cut, causing short term interest rate futures to rally strongly, especially Eurodollars. With so much uncertainty in the markets we judged Eurodollars had rallied a long way quickly and would struggle to go further. Moreover, if they did, profit-taking would set in.

Our judgment proved sound, although Eurodollars continued to test the highs as equities initially failed to respond to the monetary policy stimulus, they have since reversed as equities have started to short cover.

What is behind these very large swings in the market?
The start of the sell-off was due to several factors, but mainly:
- Intensifying fears of a deep US recession, and
- Disappointment that the Fed hadn’t eased last Friday when President Bush announced his emergency fiscal package.
But in addition to this, traders have become increasingly concerned about the Bond insurance market and the solidity of the institutions writing the insurance.

This market is huge; approximately US$36,000B, or roughly three times US GDP. The fear in the market had evolved from Sub-prime mortgage default, to what happens if the players in this market fail?

Clearly, even a relatively small percentage default in this market would dwarf the losses caused directly by sub-prime and have wider systemic ramifications.

These worries were behind Tuesday’s poor equity market response to the Fed’s emergency action, as traders either

perceived the cut as too little too late,
the Fed slipping into panic mode.

However, since then the authorities have contacted several leading US Banks in an effort to launch a safety net fund in case one or more, of the Bond insurance issuers defaults. The contributions sought are approximately US$15.0B, and this news is behind today’s equity recovery.

But will the Banks oblige? Many leading US Banks have announced huge writedowns, suffered very large declines in their 4th quarter profits and several have gone cap-in-hand seeking substantial capital injections, with only the sovereign wealth funds of the Middle and Far East either willing or able to provide.

In this very uncertain environment the Eurodollar market, although bullish, is likely to remain volatile.

With the regularly-scheduled FOMC meeting due next week, the market expects the Fed to deliver another cut; will they oblige? While we expect rates to fall further, surely the Fed has to balance what the market wants, against retaining sufficient ammunition to respond if matters worsen further, as we think they will.

The dynamics driving markets are multi-faceted: the Fed is clearly worried that the economy is at risk from forces beyond a mere deficiency of demand. Their eye is focused on systemic risk.

The Technical Trader’s view:
In some respects the Eurodollar market is rather devoid of patterns but there is a channel...


The massive bull channel from the lows of 2000 has been smashed by the violent price action over the last week.

Look closer.

And a medium-term channel can be imposed on the chart, but neither of these channels has been very powerfully described.

However, note that the market is having difficulty sustaining itself though the boundary.


In fact today the market has pulled back violently.

The Gap (97.38-51) formed on the way up – around the Boundary of the long-term channel should be good support.... a close below that level would be very bearish.

Mark Sturdy
John Lewis
Seven Days Ahead

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