Is trading short-term rate expectations worthwhile?

Work in progress

You be the judge.

To the left of the chart below you’ll see position valuation relative to the market’s priced in rate change between the March 2019 and December 2020 deliveries from 2012 through 2018. These expectations are based on the value of 15+ trillion US dollars in the face value of open contracts.

1 position  = 10 contracts long & 10 short, margin per position has never exceeded $3,800.00 USD, each 0.01 change = $250.00, we can trade this position just as easily short as long.

Disclosure

Position valuation is calculated from zero anticipated rate hikes,

Positive = a priced in rate increase between delivery months
Negative = a decrease in rates between delivery months

On the 13th of September 2013 we were trading at 0.4800, translated the market had priced an increase in rates between March 2019 to December 2020 of 0.4800%, each 0.01 = $250.00, position value = $12,000.00

On the 13th of September the short-term moving average (red line) on the chart below and medium-term moving average (green) moved above the long term moving average (blue) the additional indicators we use confirmed the trend reversal from down to up.

To establish a trade  consistent with the indicators you would buy (long) 10 March 2019 (GEH19) contracts and sell (short) 10 December 2020 (GEZ20)  expecting the price to increase.

Chart


Disclosure

On the 18th of December 2018 the short-term moving average (red line) and medium-term (green) moved below the long-term (blue) additional indicators we use on this page confirmed the trend reversal from up to down

Entry 0.4800 long position value = $12,000.00
Reversed to short at 0.6600, each 0.01 = $250.00, position value = $16,500.00, Gross profit = $4,500.00.

To reverse this position from long to short we’d sell (short) 20 March 2019 (GEH19) contracts and buy (long) 20 December 2020 (GEZ20)  expecting the price to decrease.  The first 10 of 20 offsets the 0.4800 long the second of 20 creates the net new short.

Net new position (short) 10 March 2019 (GEH19) contracts and buy (long) 20 December 2020 (GEZ20) . This position was maintained and eventually reversed to long on the 31st of January 2013. 

Chart


Disclosure

Now let’s review a short position using current data where rate expectations go from +0.3050 to a  -0.0100

On the 13th of November 2018 we were trading at +0.3050, each 0.01 = $250.00, position value = $7,625.00

The short-term moving average (red line) and medium-term (green) moved below the long term (blue), additional indicators we use confirmed the trend reversal from up to down 

To establish a position consistent with the trading methodology you would reverse your existing long to short expecting the price to move lower.

On the 13th of November 2018 our current long was reversed to short at 0.3050 each 0.01 = $250.00, position value = $7,625.00

To reverse a position fro long to short we’d sell (short) 20 March 2019 (GEH19) contracts and buy (long) 20 December 2020 (GEZ20)  expecting the price to decrease.  The first 10 contracts (of 20) offsets the 0.4800 long the second 10 contracts (of 20) creates the net new short.

Net new position (short) 10 March 2019 (GEH19) contracts and buy (long) 20 December 2020 (GEZ20) .

Chart

On the 6th of December 2018 we were still short at 0.3050 the markets settled at -0.01 indicating the 15 trillion USD in open positions was pricing in a rate decrease between March 2019 and December 2020.

Short Entry =  0.3050%, value = $7,625.00 (13th of November 2018)
Current = – 0.01, value = -$1,250.00  (6th of December 2018)
Each 0.01 = $250.00
Open trade equity = +$8,875.00

Please remember we are measuring valuation from 0.00 a positive number equals an expected increase in rates between delivery months, negative a decrease.

To calculate rate expectations between delivery months you take the nearby delivery and subtract the forward in the example below we’re subtracting December 2020  97.215 from March 2019 97.205 indicating a priced in decrease in rates between March 2019 and December 2020 of -0.01% on the 6th of December 2018. 

delivery months currently trade out to September 2028, you find this market will give you better rate expectations that the majority of fundamental analysts.

Quotes

To calculate the priced in rate exceptions between March 2019 and December 2023 you’d subtract December 2023  97.10 from March 2019 97.215 indicating a priced in increase in rates between March 2019 and December 2020 of +0.105%  on the 6th of December 2018.

The Instrument we’re trading

For more information about this contract

3 month rates or Eurodollar deposits, are time deposits denominated in U.S. dollars at banks outside the United States. (There is no connection with the euro currency or the Eurozone).

Eurodollar futures contacts reflect what the market believes 3 months rates will be during the contract delivery month,

The price of the March 2019,  97.140, it’s telling us the market believes that 3 month rates will be at 2.860% during the month of March 2019.

To calculate the rate the contact price represents take 100.000 – contract price = the rate, 100.000 – 97.140 = 2.860%

Quotes

5) The type of trade we use to capture this move is called  a spread.

For more information on spreads

Choosing a Spread Strategy

Choose a Steepening curve strategy (increase in price between two deliveries)  when the market anticipates interest rates will rise faster in the forward deliveries than the nearby deliveries, example, nearby would be March 2019 forward December 2020.

Choose a flattening curve strategy (decrease in price between two deliveries) when the market anticipates interest rates will rise faster in the nearby deliveries than the forward deliveries, example, nearby would be March 2019 forward December 2020.

Doesn’t the Federal Reserve provide guidance on the US economy and the rate they set?

Yes but you have to remember the Federal Reserve is and has been absolutely clueless about the US economy and the rate they set since Alan Greenspan became chairman. Pre Greenspan the saying was never fade the Fed, now it’s fade the Fed. If you match actual price action against the Fed Statements on Fed’s website more more Fed Chair bad calls see this link.

From the Fed’s post meeting press conference the 26th of September 2018

Fed’s expectations for rates after the 13 June meeting 2018

8) Check historical levels for rates

At the Fed’s target of 3.40% the Fed Funds rate will still be 3.21% below the 1968-2007 per-financial crisis average of 6.61%. 

Period Fed Funds 3 Month CPI Rate – CPI
Current 2.15% 2.25% 2.50% -0.25%
1968-07 6.61% 5.96% 4.49% 1.47%
2008-18 0.75% 0.65% 1.83% -1.18%
Pre/Post + – -5.86% -5.31% -2.66% -2.65%

9) Match what the Fed is telling you about the rate they set to what’s priced into the market

17 trillion in open derivative positions is telling us there will only be an 0.18% increase.

Somethings not right here, the market is telling us we’ll only see an increase of 0.180% but the Fed that sets interest rates is telling us 1.00 this aberration creates our opportunity.

Chart

10) You double check other interest rates here

11) Double check Stock Indices here and decide the stock market is currently healthy (this was 9 September) and conclude there is no justification for rates that are less than 1/3 the 1968 to 2007 historical average

Chart

12) Calculate risk reward (call me for how short positions)

0.1800 position value $4,500.00
1.0000 position value at the Fed’s expectations =  $25,000

If  market expectations go to zero your down $4,500,
If the Fed is right about rates they set you’re up $20,500.

Because rate expectations could go negative you decide to capitalize each position with $10,000, for you to “blowout” you’d have to see rate expectations move from a positive 0.1800% to a negative -0.2200%

13) You decide you’re good to go and lay down 10 positions 

Capitalize the trade with $100,000 knowing that your OK on margin even if rate expectations moved from a positive 0.1800% to a negative -0.1200%.

You place an order to sell 100 December 2020 (GEZ20) contacts and buy 100 March 2019 (GEH19) +0.18 to March 2019

  97.240  March 2019 (GEH19)
– 97.060  December 2020 (GEZ20) 
  0.1800 = expected increase Mar 2019 to Dec. 2020
$45,000 = Position value to zero (100 contracts)

14) Your valuation chart now has an extra 0. and each 0.01 move = $2,500

Chart

15) From the 6th of September through the 6th of October your position has appreciated from $45,000 to $110,000 and the liquidation value of your account has gone from $100,000 to $155,000 in one month,  on one trade.

Chart

16) From the 7th of October to 10th it’s a different story,  the position sells off hard, position value drops from $110,000 to $95,000, the value of your account falls from $155,000 to $145,000,

At 0.4400, no lower than 0.3800, every key technical indicator is telling you to get out of you long, and go short

Chart

17) You check your rate analysis page  again confirming the sell,

18) Check the technical indicators for the indices on this page,  on the 10th there was 130 point sell off in the S&P, all index indicators we showing a sell.

Chart

18) Check the news online and all other private feeds. On the 10th, it wasn’t looking to promising for either stocks or rate hikes.

19) Decide to liquidate and if aggressive go reverse to short.

Chart

$46,100 = Net profit (calculated using worst possible on order fills & fees)

20) Initial Entry

Buy 100 March 2019 (GEH19)  Sell 100 December 2020 (GEZ20) contacts +0.18 to March 2019  (worst possible fill was 0.180 if you used no price order)

  97.240  March 2019 (GEH19)
– 97.060  December 2020 (GEZ20) 
0.1800 = expected increase Mar 2019 to Dec. 2020
$45,000 = Position value to zero (100 contracts)

21) Liquidation

Sell 100 March 2019 (GEH19)  Buy 100  December 2020 (GEZ20)  +0.38 to March 2019  (worst possible fill was 0.380 if you used no price orders and legged out)

  97.145  March 2019 (GEH19)
– 96.765  December 2020 (GEZ20) 
0.3800 = expected increase Mar 2019 to Dec. 2020
$95,000 = Position value to zero (100 contracts)
$50,000 = Gross profit
-$3,900 = Worst case costs all fronts, orders, fees, fills and whatever else.
$46,100 = Net profit

For my own account I would look at this an an opportunity to short

22) Looking at just the March 2019 (GEH19)  December 2020 (GEZ20) spread there have been numbers opportunities to capture moves of the magnitude on both sides of the market

Current Chart

If you decide to become one of our clients I’ll share additional strategies in the Global Interest Rate markets with a higher return on risk

23) Global Interest Rate markets we trade

US Rate Futures Year to Date Price Change
US Rate Futures Long, Short, Hold Summary

International Rate Futures Year to Date Price Change
International Rate Futures Long, Short, Hold Summary

Analysis Pages EMA 9 Chart Long, Short, Neutral
3 Month Chart Opinion
30 Day Fed Funds Chart Opinion
2 Year Chart Opinion
5 Year Chart Opinion
10 Year Chart Opinion
30 Year Chart Opinion
3 EuriBor Chart Opinion
3 Month Sterling Chart Opinion
Euro Schatz Chart Opinion
Euro Bobl Chart Opinion
Euro Bund Chart Opinion
Euro OAT Chart Opinion
Euro Buxl Chart Opinion
US Rate Quotes Euro Rate Quotes Priced In Rate Hikes
Treasury Yields Treasury Calculator All Fed Statements
Rate News, Past Hour Rate News Past 24 Hours Rate News Past Week

24) Structure

Exchanges we trade on
Brokerage firms
What an ATA is and how they work
Fee structure
How to define overall risk on your account
How balances are protected
Open An Account

If you have any questions send a message or contact me

Regards,
Peter Knight Advisor

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