Yeah, indeed... I have been looking at this stuff again recently, 'cause there's been a lot of activity in the past couple of days. Basically, it's all just based on the expectation among many market participants that the Fed will do what had been mentioned in the minutes recently. Specifically, this is the key passage: "One of the policy options discussed was an extension of the period over which the Committee expected to maintain its target range for the federal funds rate at 0 to 1/4 percent. It was noted that such an extension might be particularly effective if done in conjunction with a statement indicating that a highly accommodative stance of monetary policy was likely to be maintained even as the recovery progressed" If they do this (and there's a lot of people who expect this to be announced at Jackson Hole), it would have the effect of causing the Eurodollar strip to look even more hockey stick-like than it does at the moment. I think you can observe the extremes of this sort of pricing of the strip at the end of 2002/beginning of 2003.
I also am very interested in this. I think one could have some trades based on further extension of zero rates, but also, alternatively, some based on a potential sudden abandonment by the Fed of its zirp policy at a later date. Already some economists say rates need to be increased. I could see this notion creeping into the market at some point and then accelerating suddenly in a variety of scenarios including any one of : change of management at the Fed, dollar crisis, economic recovery, etc. These are opposite trades in a way but could be done with options or possibly other ways too.
Yep, so this is definitely a theme that's playing itself out in the mkt over the past few days (driven by all sorts of forecasts for what exactly happens at Jackson Hole). For example, one type of trade is various structures that oppose the "hockey stick"'ness of the Eurodollar strip. For example, buying the u4u5u6 fly is a trade that performs really well in the extremes, i.e. either 1) a robust economic recovery and early Fed hikes, or 2) another 5 yrs of really painful deleveraging, uncertainty over the fate of the Eurozone etc, where Fed is on hold for a long long time. It might also perform if/when the mkt prices Bernanke going away. Problem with these types of trades and the reason why they look so attractive at the moment is that they "fade" the "extended guidance" language. A trade of this sort went through yesterday (probably more of a "Bernanke goes" rationale) with someone selling 16.5 bags of the h3m3h4m4 condor (sold h3m3 vs bot h4m4). Today it's been all about the other theme, which is, basically, to oppose the steepness in the back greens and blues through options. So you write off some premium to buy some straight upside in blues/golds. The rationale for this is just that people are expecting some sort of "extended guidance" language to be announced at JH. These went through in pretty massive size today, as well as yesterday. For example, someone bot 40 bags of the gold Sep midcurve (14Sep2012 expiry onto the u6 contract) 98.75/98.875 call spreads for a tick.
Sorry, my bad. A bag is 1000 lots, so 16 bags of Eurodollar condor is 64,000 lots in total, across all contracts.
I thought I also should include a picture to represent what things look like and what the risk is. The chart shows the Eurodollar strip today, as well as in mid-2003.
To get the kind of size off you're talking, do participants need to enter an OTC voice market or can you move that kind of wood on the screen? If I am reading this correctly, long u4/u6 and short u5 to try and take advantage of the bend either flattening or moving further out on the curve. I was looking a bit at trying to structure this and I think you're right, in either scenario that fly seems to have flattening potential. I'm sure you've read this, but for those who haven't: Monetary Policy Alternatives at the Zero Bound: An Empirical Assessment Just speaks to what you mentioned, MG, in that his policy announcements seem to be his only weapon at this point. Pg 30-31: "The event-study analysis shows that FOMC policy statements do in fact have a substantial impact on the marketsâ expectations of future policy, both directly and indirectly, suggesting that the Committee does have some scope to use communications policies to influence yields and prices of longer-term assets. To assess further the magnitude of these effects, we next estimate a âmacro-financeâ model of the term structure of Treasury yields, which links the term structure to macroeconomic conditions and to indicators of monetary policy. Comparison of this benchmark model of the term structure to the actual evolution of yields provides additional information on the magnitude and duration of the effects of FOMC âtalkâ on the term structure."
That's quite a different picture than I have for my curve. Is there a benefit to viewing the curve in terms of yield as opposed to fixed price?
You can do either and there's no real tangible benefit either way. Because I trade other products that are quoted in yield terms, when doing analysis I find it a bit easier to look at futures in yield also. In options, you definitely need to go through a voice broker. In futures, you can certainly get stuff done on the machine (although you might need some sort of a spreader tool for the more fanciful structures), if you're patient. Sometimes people also do large futures trades through voice brokers to improve the execution, but mkts in flies, spreads, bundles etc are all there accessible electronically.