Wednesday Oct. 15 will be remembered for a long time as the day the dam protecting fixed income shorts gave way to a violent short covering rally. A week earlier, the minutes from the Fed’s September meeting were released, revealing the Fed’s concern that the weakening economic conditions in the Eurozone, Russia and Asia could spread to the United States. Up until then market focus was largely on continued steady U.S. economic growth and pricing in expectations that the Fed would begin tightening rates in the first or second quarter of 2015. All of this is now coming into question. All along the Fed has made it very clear that their decisions are data-dependent: for the past couple of weeks the data started to show cracks and equities were paying attention. Oct. 15 may have been the perfect storm: further weakness in the equities, poor data in the way of retail sales, empire manufacturing, along with decreasing inflation in the way of PPI and a massive amount of fixed income shorts that were feeling pain. Oh, and, of course, there is all kinds of fear surrounding the Ebola pandemic.
On Oct. 15, markets opened fearful but in a blink of an eye fixed income prices were screaming higher at an unbelievable pace. Action in the Eurodollar was violent, reaching record-breaking volume of 11,532,544 and shattering the previous record of 6,880,382. Price action in the Eurodollar complex was unlike anything I had ever witnessed before with prices moving violently higher fueled by massive short covering. Thursday’s open interest report revealed a decrease of 442,203 confirming the liquation of shorts. I have highlighted the Eurodollar June 2017 contract as it experienced the biggest decrease in open interest, -83.794 (see chart below). The chart shows the extreme move higher but what is most interesting is that it has retraced most of the move higher by now. Late in Friday’s session the EDM17 was trading just below 9800, implying Fed Funds will be less than 2% for almost another two years.
With so many positions cleared out, Thursday and Friday’s (Oct. 16-17) sessions were spent establishing new positions, taking into consideration adjusted economic and Fed expectations. Since Wednesday there have been a number of Fed speakers acknowledging world economic weakness and the possibility of more Quantitative Easing (QE) should the need arise. However, these statements came in qualified form. For the most part, speakers felt that weakening conditions globally would not derail the U.S. economy. As of Friday’s close, expectations for the first instance of Fed tightening now fall between December 2015 and March 2016. One comforting fact through all of this is that the Eurodollar complex withstood the massive volume assault without a hitch.