More 1937 paranoia http://online.wsj.com/article/SB125107325090852627.html (if you cant see the article, copy and past the title in google and click the link, this will allow you to see all WJS articles for free) I believe its quite possible that in 2011 I will still be talking about fed futures and how I hold a large position on it. Its easy money, its the largest trend from 2007 to now(it goes up almost frigging month), yet almost nobody talks about it. One can think what the hell I'm doing fighting the stock uptrends well I hold a huge position in the largest trend since 07, I feel that I can take a punt at shorting this market, it hasn't been fun and I remain skeptical of it. Its like the little brother who messes up with the bigger brother then runs, its only a matter of time till he gets his ass kicked, maybe not today or tomorrow but its coming
Christian Siva-Jothy put it best "When I see dislocation in the direction of pain in the US economy I buy Eurodollars, its not brain surgery" "When the Fed is in agressive cutting mode I want to be long Eurodollars, because its the most obvious trade in the most liquid market in the world. I dont want to be long South America fixed income or anything when there is a clear trend in a liquid market" I dont use ED because you have to predict libor as well and I dont like to have to do that, Fed futures nets that out. The liquidity is lower but I'm not trading millions in a hedge fund so it suits most perfectly
Bernanke reappointed. Its probably not THAT big of a deal, he changed the voting order of the FOMC. Greenspan would vote first and few would have the guts to go against him, now Bernanke is the last so his leverage is dimished. Still, back in Sep 08 he did made a speech urging the FOMC to ease, they global eased a bit after so the chairmain still has some prestige and power
Just made a dramatic change in my portfolio. I'm taking profits in most Fed Futures(still keeping a few in the Feb May zone for the unusual exigent arb) but I'm buying GE(CME eurodollar) calls! I had just said I didnt like eurodollars because of the libor component and I still dont but Fed Futures options cannot be traded through IB because of some issues they have. I just loaded up on GE 99.00 Dec 2010 calls, I paid 0.125 for these(Dec contract at 99.125+ at exp and I'm cashing). These contracts are expiring at 99.61, if that happens in Dec 2010 I make 48.5bps(FOUR times my risk), for that the fed needs to stay low(seems likely) and libor not blow out that month(During the Jan-Mar sell off in equities and corporate bonds, when C debt was yielding 25% YTM, libor blew up only 25bps). The lehman crisis is over and the government would deal with another libor blowout by more QE, bailouts, saying 'no more lehmans' etc. So I expect a libor blow out to be temporary. Heck the financial crisis will almost surely be over by Dec 2010, its possible that I make money on the libor spread tightening as well
And the most important thing I'm increasing my reward by DECREASING my risk. ZQ contracts are highly levered(they are worth $400k each but the margin is only $1k), my gross leverage was running at 60x(FNM levels, although that surely overstates the risk), I had blowup risk in case bernanke mispoke, green shooters kept going mad, dollar crisis,etc I was just not comfortable with the black swanish scenario of a huge drop in these contracts. With the GE calls now if I'm wrong I will just lose my premium, if right I'm going to cash in big I cant believe I missed this one before, had I bet big in those in the past I could have had a monster return
I do expect libor to go up at some point, that could very well happen because TARP might run out of funds, bank earnings will dissapoint(Even Bove is saying banks are going to lose money), credit spreads should widen. But the Dec 2010 GE contract only cares about the libor in the last trading day in Dec 2010, by then the economy will be expanding(probably weakly though) and the financial crisis should be over
I'm also long the fat talish scenario where the fed stops paying interest on reserves(this one actually seem likely) then starts to tax reserves(negative rates) to encourage lending. If the core CPI keeps falling this seems possible, in that scenario those calls will go to the moon, do a bathroom break, then head straight to Orion. 30 times my risk could occur
Now that I'm long Dec 2010 eurodollar calls, I'm taking quite a bit of fed hike risk However even if the fed hikes once(to 0.5% fed funds with a 15bps 3m libor spread over overnight fed funds, I assume a low spread because the fed would not raise in case libor is unstable), I still almost triple my money. If they hike twice I get a small loss, three times I lose the entire premium I do believe is likely we will see no hikes in 2010, that is because it takes an average of 14 months after the unemployment rate peaks till the fed raises rates. The unemployment rate has not peaked(NFP is negative, last month labor force abnormalities created the drop), the 90-91 credit crunch experience suggests a jobless/weak recovery('the recovery was one of the most sluggish on record' - greenspan). Jobless recoveries tend to add 1% to the UR. This suggests something like 10.6-11% UR in 2010 and a first hike in 2011 So my core position right now is to keep rolling over short-term contracts in fed funds futures(picking up the historical premium plus the 'unusual exigent' arbitrage), long those eurodollar calls(giving 4-1 odds in a likely scenario) and long XLF puts(which of course, are going down), a few other shorts as well but the big bet is on interest rates
http://online.wsj.com/article/SB124986234040818217.html 'Since the 1970s, the Fed has waited 14 months, on average, after unemployment topped out to tighten the screws on the economy.' Its possible that this time around it will take even longer because we had a secular decline in inflation and inflation expectations, so in the 70's and 80's it was more important for the fed to act early, distorting the average. Right now with CPI at -2% Core CPI at 1.5%(and going down), the 10y expected inflation at 1.74% and the historical fact that commodity inflation pass through is usually very low(something like 22% this decade) makes worries about deflation exist, which mostly did not in that 14 month avg data