December 14, 2016
Eurodollars ARE now moving…
But I believe the Rise in Rates has barely started.
What a surprise? Less than 3 months ago, the Federal Reserve Board was indicating that they would raise rates only twice in 2017...Yesterday afternoon, due to assumedly stronger than expected economic developments, they are NOW anticipating THREE raises next year.
As I have written for months, nothing about Fed policy is EVER written in stone…that there is not a single Fed Governor who will tell you, “We KNOW what is going to happen.”, which is exactly what was evidenced by the news coming out of yesterday’s meeting…And I can assure you, with the fact that 2017 isn’t even here yet, those expectations that just changed from 2 to 3 raises next year can just as EASILY change into 4 or 5 or more. Also, having examined all the previous Fed tightening cycles since 1988, I will tell you that it is NOT uncommon to see more frequent raises than anyone is expecting, and it is also NOT uncommon for raises that are expected to be 1/4 %, suddenly becoming 1/2 percent surprises (bigger than publically anticipated).
The past does not predict the future but it can be a guide…With this in mind, here is how the past four Fed rate raising cycles unfolded:
Feb 1988 to May 1989 – From 6.5% to 9.75% - 3.25% INCREASE IN 15 MONTHS.
May 1994 to Feb 1995 – From 3% to 5.25% - 2.25% INCREASE IN 8 MONTHS.
June 1999 to May 2000 – From 4.75% to 6.5% - 1.75% INCREASE IN 11 MONTHS.
June 2004 to June 2006 – From 1% to 5.25% - 4.25% INCREASE IN 24 MONTHS.
All that being considered (especially with what I think we are about to see coming out of Washington) it is EASY for me to envision rates being AT LEAST 1.75% to 2.00% higher by the end of 2017.
And with further regard to Washington, what I find highly interesting is that Janet Yellen yesterday stated that the Fed’s decision to raise rates by 1/4 percent…as well as their expectation that rates might be going up faster than previously anticipated…was not based on assumptions as to economic impact of Trump’s (and Congress’) rabidly stimulative policy intentions…In fact, in her post meeting press conference, when asked if Trump’s policy proposals did (or might) influence the Fed’s decision making, Yellen answered: “I wouldn’t want to speculate until we’re more certain of the details and how they would affect the likely course of the economy.”
As she has to be careful not to overstep her bounds as Fed Chairperson, she basically just said, “ We’ll wait and see what happens first.” But I do not have those constraints so…I WILL speculate as to how the economy, the markets and the Fed will be affected…
I BELIEVE THAT THE NEWS GOING FORWARD, FOR MANY MONTHS TO COME, IS GOING TO BE JAMMED WITH HEADLINES THAT IMPLY NOTHING BUT A HIGHLY STIMULATED AND RAMPANTLY EXPANDING ECONOMY…WITH A VERY DEFINITE IMPACT ON INFLATION…AND THEREFORE CONTINUE TO BELIEVE THAT INTEREST RATES WILL STILL BE RISING FASTER AND BIGGER THAN ANYONE ON WALL STREET, AND THE MARKETS, ARE CURRENTLY EXPECTING.
The demand for money…borrowing…is ONLY going to be increasing as the year unfolds, and increased borrowing DOES mean higher rates…Simplified, there is not a single banker in this country who is going to be lending at the lowest rate he can when people are beating down his door looking for financing. And as I have written before, virtually ALL of the roads, bridges, schools, infrastructure, etc. that Trump wants to build WILL mean, as soon as the contracts get signed, that BUSINESSES WILL BE HEADING TO THE BANK TO BORROW…In other words, the government might appropriate funding, but no builder or contractor gets paid up front. The first thing they have to do is find a lender…And I also maintain that all of this new borrowing is coming at a time when the economy is ALREADY in a ramped up mode…and Washington will only be adding more fuel…a LOT more fuel…to the fire.
EURODOLLARS ARE ALREADY ON THE MOVE, HAVING JUST MADE NEW 11 MONTH LOWS, BUT I FIRMLY BELIEVE THAT THE MOVE UP IN RATES IS JUST GETTING STARTED… and if the past is any guide at all…the tightening will continue for AT LEAST the next 12-18 months…The truth is, it has been so long since the Fed’s last tightening cycle that an old rule of thumb has seemingly been forgotten, that being that Fed changes in interest rates can easily take 12-18 months before the impact of any specific action produces its desired impact…In other words, if you want to head off inflation, or an overheated economy, what you CAN’T do is wait until the problem is in your face…It HAS to be anticipated by the Fed, as, in reality, any actions by the Fed TODAY probably won’t show up as a restrictive influence for at least a year...To clarify, one might guess there isn’t a business out there that had its immediate plans affected by yesterday’s announcement…but maybe its FUTURE plans might have been.
I do think the move up in rates, and
DOWN IN EURODOLLARS, has barely begun…
I am still buying Eurodollar puts.
What to do right here?
First up, for better perspective as to how this market CAN move, here is a longer term picture of the September, 2017 Eurodollars, plotted on a weekly basis and going all the way back to 2010 when this contract came on the board…
Here is the put option I am buying at current levels…
I might be dead wrong but I think 98.00 almost looks like a given…The truth is, my actual target here is more like 97.50…One thing I think I know…This market is NOT just going to lay here sideways…
When you get down to it, markets do move on news…and I think there is going to be PLENTY of bullish-for-the-economy…and bearish-for-interest-rates… news coming out of Washington in the months ahead…So what do YOU think we will be potentially hearing between now and next summer? ANYTHING that implies rates still need to “stay low?” I’d love to hear what YOU think.
Give me a call if you think this makes sense, and if you have the risk capital and the temperament to be fooling with this sort of investment…
And to those of you who are already on this, I think using this option to add makes sense here…For what this market can do, they still look dirt, dirt cheap to me.
All option prices in this newsletter include all fees and commissions.
The author of this piece currently trades for his own account and has a financial interest in the following derivative products mentioned within: Eurodollars