Oct 9. The Fed put. Preserve the “wealth effect” at all costs

–FOMC minutes sparked a huge burst of buy orders, without apparent concern for product code, as interest rate futures, stocks, gold and currencies surged.  Green eurodollar pack was the star performer, up nearly 12 bps.  5 yr treasury yield fell about 9 bps to 155, and tens were down a couple as the curve steepened from 5’s back.  Minutes cited dollar strength as a risk to inflation goals, with possible “adverse effects on the US external sector.”  The market digested the 26 pages of minutes with two words:  No tightening.
–By the end of the day most near eurodollar calendar spreads had sunk to new lows.  The peak one-yr spread is EDU5/EDU6 which fell 3 to 103.  The near one-year calendar spreads that should be pricing in twelve months of potential Fed tightening are EDZ14/EDZ15, which settled 68, (down 8 bps! on the day), and EDH15/EDH16 which settled 89, down 6 on the day.  Perhaps as clear as anything reflecting market perceptions of Fed actions is FFQ’5, August 15 Fed Fund contract.  There are 5 meetings in 2015 prior to this contract, which had spent the middle of September near 9950…an indication the market expected a FF rate of 50 bps by the July 29 meeting.  Yesterday this contract settled 9971.5, +7.5, much closer to 25 bps than 50.
–Is this really good for stocks?  Colleague John Brady thinks it’s a clear signal that the Greenspan/ Bernanke/ Yellen put is alive and well.  I am not so sure, but there is no arguing with an outside day with a huge range that closed near the high.  Reversal signal, pure and simple.
–It’s hard for the Fed to jawbone against dollar strength, when the EU and Japan have made weaker currencies a centerpiece of their policies to stoke inflation and grow exports.  No question that those policies are disinflationary for the US, but a reversal of dollar strength may mean that other parts of the world have a much more difficult task of escaping the quagmire.  Is crude oil, the one thing that couldn’t rebound after a relentless sell off, an indication of dwindling global demand and prospects?
–Out with the puts, in with the calls.  Prior to the minutes there was a buyer of 80k EDZ5 92/95c 1×2 for 2.5 and 30k EDU5 92/95 c 1×2 for 4.5, both long term plays for a Fed on hold and a grinding roll up the curve.  Green and blue Dec midcurve puts were sold.  After the minutes 40k Short red June 9825/9800 put spreads were sold at 6, another exit.

Posted on October 9, 2014 at 5:16 am by alexmanzara · Permalink
In: Eurodollar Options

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