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Watch the US futures strip – it’s telling us something...

25 September 2008

The Macro Trader’s view:

On the 16th September the Eurodollar market spiked to new recent highs and then during the same session abruptly sold off. The reason for this dramatic price action is now well known: the collapse of Lehman brothers followed by the nationalization of AIG.

The initial rally was driven by hysteria in equity markets that saw financial stocks sold particularly aggressively, but when the US Government stepped in to rescue AIG and the Fed failed to ease policy to counter market turmoil, as was widely expected, choosing instead to reiterate policy makers’ concerns over inflation, Eurodollars sold off and have sold off hard over succeeding days.

A contributory factor was also the announcement by Treasury Secretary Paulson of a plan to create a special vehicle to buy all the ‘Toxic’ assets sitting on Banks balance sheets which lead to the view that policy was more likely to be tightened if this plan went ahead.

However there is much dissent among members of Congress and the hoped for rapid passage of a bill enabling the rescue has become bogged down.

This has lead to pleas from the administration, from Bush down to support the plan or else the economy will suffer a deep recession.

In all likelihood the economy will go into recession anyway:
- The housing market correction seems to go on endlessly, and
- Jobless claims hit 493k today, a level which is usually consistent with the economy already being in recession.

So why are Eurodollars almost uniformly pricing in higher rates across the futures curve?

The Fed squashed all optimism of easier policy at the last FOMC meeting, choosing instead to pump in extra liquidity at the same interest rate. But if the Banking industry isn’t fixed soon, the economy will slow inexorably on the lack of credit. This could then turn fears of inflation to fears of deflation and force the Fed to cut rates further, almost to zero.

Currently the Fed remains focused on monitoring inflation and providing a flood of liquidity, but if the rescue plan isn’t voted through, or the version that is doesn’t live up to expectations, equity markets will resume their slide and change the Feds priorities.

As ever timing is crucial and it isn’t yet right for a trade, but it might soon be.

The Technical Trader’s view:


The Eurodollar futures strip is almost flat - uniformly pricing in higher rates in the future.

But notice that the near months have fallen hard to the lows of June this year.

There was once optimism in the near term – which has now disappeared

Now look along the strip...


Even though the market here is still pricing in higher rates notice the technically more powerful position:

The market remains well above the June lows.

Certainly the support from the prior High 96.44 is being tested (and may have broken today).

But the relative strength (technically) of the far end of the futures curve is clear.

Mark Sturdy
John Lewis
Seven Days Ahead

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