Eurdollars — A “once-every-five years” trade

 

The Eurodollars do not change trend very often, but when they do, new trends last an average of five years. We are on the verge of a new trend – the first downtrend since 2004.

Eurodollar futures have been one of my most favorite markets to trade over the years. The Eurodollar market reflects the interest rate on U.S. Dollars owned and deposited overseas. The market is priced at 100 minus the interest rate. So, if the interest rate is 1%, the price will be 99.00, 2% will be 98.00 and so on.

Eurodollars are among the most actively traded of all futures contracts, rivaling S&Ps and Crude Oil in volume. The Eurodollar market is unbelievably liquid. The value between minimum ticks (1/2 point) is $12.50 and the bid and offers are tight and sizable. Eurodollars cannot trade above 100.

When Eurodollars trend, they really trend. It is one of the best trending of all futures contracts. For example, using a very long-duration moving average of 65-weeks (325 days), there have been only six directional changes in the moving average since 1982 (excluding a period of interest rate uncertainty in the late 1990s). That is an average of a trend change every five years. To be more specific, the long-term moving averages have turned down only four times in 30 years.

Importantly, the long-term moving averages are NOW turning down. Further, the extensive monthly chart topping pattern we are currently seeing has only occurred two other times since Eurodollar futures have traded (in 1992-94 and 2002-04). Each of those previous times the actual Eurodollar interest rate rose 400 basis points (futures prices dropped 400 basis points).

The decline on the weekly chart is approaching an extremely important price level. The May 2010 low at 99.17 (near contract) is the mid-point low of a massive 29-month “M” or double top. A decisively close below 99.00 would complete this top and indicate a drop to 96.00.

A significant development has occurred within the internal pricing of Eurodollars. In recent years the deferred contracts have been priced at a premium to the near contracts, an indication that the market place has anticipated a future hike in short-term rates. The yield curve in Eurodollars has gone basically flat, as shown by the near contract and the June 2013 contract. This spread has moved from 434 basis points premium the June 2013 contract to only 14 basis points wide.

The significance of this is that speculators can short the deferred contracts without giving away a big carry. So, while the market itself appears to be topping, the back months are priced very attractively for a short campaign. The only thing I can think of that would push the spread into an inverted structure with the nearby contracts priced lower than the deferred contracts would be signficant deflationary pressures.

$GE_F, $WE_F

 

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The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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