September 23, 2021
Buying More Eurodollar Puts
Back in March I began making a case for an increase in short term rates, with my recommendation having been to buy the March 2022 Eurodollar 9975 puts, which were then priced between 4 & 5 ticks…So 6 months have passed with rates, and Eurodollars, having remained sideways, those options, while still having about 6 months until expiration, are now trading at 1.75… and are still viable as I believe ANY hint that rates are about to rise should immediately see the Eurodollar market downtick 10-15 points…just as a jumpstart towards what will likely become a 1 to 2 year increase in interest rates…I am, however, now recommending a move further out in time, to buy the September 2022 Puts…More specifics on those puts are at the end of this newsletter.
Here’s the recommendation made earlier this year and its current status…
As always, I need to point out that this is NOT the Eurocurrency, nor does it refer to Europe…Eurodollars are Dollars on deposit anywhere outside the United States…and the Eurodollar Rate, which is identical to LIBOR (London Interbank Offered Rate), is the interest rate pertaining to borrowing or lending those Dollars…More simply stated, the Eurodollar contract exactly reflects LIBOR, which is the generally recognized as THE international benchmark for short term loans… And when short term interest rates are going higher, this is reflected by the Eurodollar Futures contract going lower.
The Fed and interest rates…
It is important to fully understand that Fed governors DO change their minds…and that they ARE guessing just like everybody else…and that they DO misread what is happening, or will be happening, with the economy…As just one example, NOBODY at the Fed saw the Mortgage Crisis and the ensuing Great Recession coming, which is not to say that they were stupid (far from it) but simply to note that they can be, and often are, absolutely dead wrong…And as regards where we are today, just because the latest Fed statement indicates that it might be mid 2022 before they start raising rates, this does NOT mean that the markets themselves (which often lead the Fed) won’t begin doing so before then…or that the Fed members won’t shift their views sharply forward on when they have to act. Again, they DO change their minds…and quite often when the markets “force” them to do so.
My opinion, all year, has been that the economy has been, and will continue to be, roaring back from last year’s pandemic induced economic contraction. Yes, Covid will continue to be a factor affecting all of our lives but it is no longer the Black Swan surprise that rocked the planet and the markets in early 2020…And yes, there will still be headlines concerning “next waves,” “surges” and overwhelmed hospitals…but the fact remains that last year’s incredibly fast vaccine developments definitively turned the economic tide this past January…as shots went in arms and the public began to “live” again. And I DO NOT SEE THAT ECONOMIC AND BEHAVIORAL “REBIRTH” EVEN BEGINNING TO SLOW DOWN…Quite the contrary, as vaccines keep coming, and supply chain kinks get worked out, I look for nothing but further economic acceleration, both here and around the globe…and therefore firmly believe short term interest rates will be going up MUCH sooner than the markets are generally anticipating…And as I noted above, I honestly think we are just one “surprisingly strong” economic or inflation report away from the Fed SUDDENLY “revising” their game plan…Again, the Fed getting caught “off guard” and having to immediately react is NOT uncommon.
Beyond my belief that the economy is getting stronger and stronger, I also think the probability of rates rising sooner rather than later jumps dramatically when you throw in the impact of the soon-to-be-passed $3 Trillion Infrastructure package.
When Congress says, “Let’s spend $3 Trillion and build out the infrastructure,” the way it really works is this:
Suppose Congress (aided by each state’s representatives, whom, whether they are Republican or Democrat, will ALL be bringing home the pork to their constituents) decrees that 1000 miles of interstate will be built in Georgia. Bids are then made, followed by contracts being granted to numerous individuals or companies for planning, designing and completing the project…And the next thing those contractors ALL do, BEFORE they go to work, is GO TO THE BANK AND BORROW THE MONEY THEY NEED TO START, AND FINISH, THEIR PART OF THE JOB…And the Banks who are doing the lending understand the game well...and ARE going to want their share of the pie…will be charging every extra 1/4 – 1/2% they can squeeze out of the deal. In other words, when people are beating down your door to borrow, the price (interest rate) of your product DOES go up.
And that is what this is all about…THAT THE GOVERNMENT DOESN’T PAY UP FRONT…WHICH THEREFORE MEANS THAT EVERY PROJECT THAT GETS APPROVED BY CONGRESS MOST LIKELY WILL MEAN SOMEBODY GOING TO THE BANK FOR FINANCING…AND $3 TRILLION IS A WHOLE LOT OF FINANCING…and that means a whole lot of LOAN DEMAND…which I can only believe means a whole lot of upward pressure on interest rates.
Federal Funds Rate…What the Fed controls…
This next chart is LIBOR…which closely tracks Fed Funds…and is specifically what Eurodollar Futures are based on…
And here’s the spot futures contract going back a few years and hopefully a clarification of how Eurodollars reflect moves when rates are going higher.
Here’s my immediate recommendation.
Why do markets go up and down? Why does the level of ANY market (stocks, bonds, commodities) change from where it is today…to a dramatically different value 3, 6 or 12 months from now? Because the overwhelming majority (if not 100%) of the time the future IS different from what today’s mass media influenced perceptions project it to be…And THAT is why markets are not just a straight horizontal line on a chart. THAT is why markets DO move up…and in this case…DOWN.
And I maintain that when rates do start going up, it’s NOT going to be a 2 or 3 month thing…but will likely go on for at least a few years…The whole idea with raising rates is to prevent the economy, and inflation, from getting TOO hot…And with the fact that it generally takes a year for ANY Fed action to actually have an effect, a few taps on the brakes won’t even come close to doing that. I therefore believe that when this starts…it will get going…and KEEP going. So what I want to do is own these now…and then do everything I can to just ride it down…for as far as I can stand to be on it.
As always, my logic might be flawed and everything I believe here might be dead wrong.
Thanks…Hope you’ll pick up the phone and get on this with me..
All option prices in this newsletter include all fees and commissions. All charts, unless otherwise noted, are by Aspen Graphics and CRB.
The author of this piece currently trades for his own account and has a financial interest in the following derivative products mentioned within: Eurodollars