January 21, 2018. RED DECEMBER

As I sometimes do, I’m starting this note with a walk down the historical market lane of my youth. (Oh no, not again!  Yes.  Again).  And it concerns millennials.  Wait, don’t stop reading yet, it’s not a social study about retail buying habits, it concerns the euro$ curve.  It was early 1999.

Back in those days, a normal trade in summer was the sale of Dec/March Eurodollars.  The spread would often decline due to the ‘turn’, related to funding demand at the end of the year, referred to as ‘balance sheet window dressing’.  Through rudimentary studies of my early years, I determined that pressure for year-end often peaked in October, reflected by pressure on front December contracts versus the rest of the curve.

Now I’m going to skip back to the year 1999.  At that time, someone began to amass a position in the Sept’99, Dec’99, March’00 butterfly.  He quietly hoovered up whatever he could, from about 13 to 20.  Think about THAT for a second.  For those that aren’t familiar with butterflies, it means that the three month calendar spread of Sept/Dec was 20 HIGHER than the three month spread of Dec/March.  Incredible, especially in the context of the past few years.  Of course, we were in a tightening cycle in 1999, so that was a factor.  Currently, Sept/Dec is 12.0 and Dec/March is 7.0, so the butterfly is 5.0  (Prices: EDU8 9779.5, EDZ8 9767.5 and EDH9 9760.5).  Back in 1999, it’s 21, and the pit community is short and uncomfortable.  I remember locals coming up to me and asking what was going on.  I didn’t know myself at first, but when it got up into the upper teens, I got wind of what should have been obvious.  And there are a couple of lessons from THAT for another time, which for now I’ll just crystallize with the locals’ mantra: “They KNOW something”.

In the latter half of the last century, when computers were just being adopted, programmers typically coded dates using only the last two digits of the year.  This was widely referred to as the Y2K issue.  Obviously, with the turn of the century, there would be a problem distinguishing between 00 for 1900 or 2000.  It was a huge race and expense to re-code all of these computers, and there were dire warnings about catastrophic consequences across all aspects of life, especially with respect to the financial system.

It’s here that I’ll insert a couple of asides, one an obscure movie reference relating to computer manipulation (just for you JC).  This was the 1995 thriller, The Net, starring Sandra Bullock -complete with slowly loading floppy disks for added suspense- a movie with a theme that one can extrapolate to system-wide computer malfunctions (as was the worry with Y2K).   The other is a Jeopardy question I just happened to see: “Embracing the future and new technology in 1962, Purdue established the first college department in the U.S. for this twoword discipline.” The answer, “What is Computer Sciences?”

Sandra Bullock as Angela Bennett in The Net

Anyway, worries for year-end funding over Y2K reached fever pitch in 1999, embodied of course, by the “millennial fly”, which exploded up to something like 70 bps.  The Fed, realizing the problem, said it would make liquidity plentifully available over year-end, and the turn hasn’t been much of an issue since then (except for a wee bit last year).

Now let’s fast forward to today. *Disc whirring*

On Jan 2, 2018, Aggregate Open Interest in Euro$’s was 12,745,080.   On Friday, it was 14,367,308, an increase of 12.7%.  Obviously, as yields have risen, the demand for hedging has increased substantially.  A particularly large change has been in the EDZ19 contract.  As shown on the chart below, open interest in that contract alone has surged from around 1m at the end of the year, to over 1.56 million now.  This accounts for over 1/3 of the total rise in open interest.

On 5-January, about 125k EDZ8/Z9/Z0 butterflies were sold at 15 to 14.5. (This position is LONG EDZ9).  That was obviously a new position, a sale against the high settle of 16.5 in the fly (16.5 settle on 4-Jan).  Since that time there has been heavy trade in many ED one-year calendar spreads, but especially buyers of EDZ18/EDZ19.  I had heard speculation that the butterfly short was covering the front spread (buying back EDZ8/9), but given the open interest increase, it appears more likely that there are several large players on opposite sides of the market.  In one of my old technical analysis classes, I was taught that the increase in open interest in a given contract was viewed as “tinder” for the next big move; i.e. someone loses the battle and needs to fire exit.  From the recent rise in rates, it appears that shorts have the upper hand.

EDZ8/EDZ9 is now at a new high of 27.0 (highest since early July).  EDZ8/EDZ9/EDZ0 is now 17.0/17.5 (17.5s), the highest in this fly over the past year, with curve roll providing a hefty tailwind (H8/H9/H0 is 32.5). On Friday, there was a new buyer of 60k EDH19/EDH20 for 19.5, causing a squeeze up to 21.5 settle.

According to prelim open interest data from Friday, EDZ8 and EDZ9 have the largest OI of any contracts, Z8 with 1.804m and Z9 1.564m.  Next closest is EDH8 with 1.374m. On Friday EDH9 OI rose 46.6k and EDH0 +56.7k (due to the spread buyer). EDZ8 rose 26k and EDZ9 +40.8k.  Total OI Friday +180k. These are big numbers.

The only conclusion I draw here for now is that large positions can create increased volatility upon exit.  I will note that EDZ9 9737.5 straddle settled 51.0, and the midcurve 0EZ9 settled 39.0.  Probably will be some scalping opportunities regarding 0EZ options.

A couple of final notes.  If Dec 31 is a Thursday or Friday, the end-of-year financing window needs to cover the weekend, exaggerating the pricing influence of the turn.  Dec 31, 2018 is a Monday and Dec 31, 2019 is Tuesday.  Also, some trading strategies regarding December contracts likely relate to the Fed’s SEP year-end FF projections.  As I have previously noted, the Fed’s 2018 year-end FF projection is 2.1%, and EDZ18 at a yield of 2.325% (9767.5) is now more or less consistent with that forecast.  For 2019, the Fed projects year-end FF at 2.7%.  EDZ9 is 2.59% or 9741.0, obviously a much lower yield than consistent with the Fed forecast.


News is fairly sparse this week though Trump’s visit to Davos should be entertaining.  Treasury auctions 2, 5 and 7 year notes.  Friday sees the initial release of Q4 GDP, expected 2.9.  The Atlanta Fed’s GDP Now has it at 3.4% and the NY Fed Nowcast stands at 3.9%.  I’m going out on a limb here and saying the risk is probably to the upside.

Late Friday the government shutdown went into effect.  Earlier on Friday, a BBG article (linked below) noted the Fed was working on proposals to ease bank leverage constraints. (That’s what we need! A bit more stimulus).  Finally, Dadong rating agency in Beijing cut the US rating and put on negative outlook due to “political ecology”, also citing tax cuts. “Massive tax cuts directly reduce the federal government’s sources of debt repayment, therefore further weakens the base of government’s debt repayment.”


23-26 Jan.  President Trump goes to Davos.  Negative implications for global trade?

End of Jan (29th?) Treasury forward borrowing estimates, likely at the end of the month. ** Important with respect to increased borrowing needs

31-Jan.  FOMC meeting.  Coincidentally, the same date will have a blue moon, a super moon and a total lunar eclipse.  Last time it happened was in 1866.

9-25 Feb. Winter Olympics in South Korea

4-March Italian elections


1/12/2018 1/19/2018 chg
UST 2Y 199.8 205.6 5.8
UST 5Y 234.7 243.6 8.9
UST 10Y 255.0 263.9 8.9
UST 30Y 285.4 291.3 5.9
GERM 2Y -56.8 -60.3 -3.5
GERM 10Y 58.1 56.8 -1.3
JPN 30Y 83.0 82.5 -0.5
EURO$ H8/H9 49.0 54.0 5.0
EURO$ H9/H0 15.5 21.5 6.0
EUR 122.00 122.20 0.20
CRUDE (1st cont) 64.23 63.31 -0.92
SPX 2786.24 2810.30 24.06
VIX 10.16 11.27 1.11




Posted on January 21, 2018 at 8:59 am by alexmanzara · Permalink
In: Eurodollar Options

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