Ag & Eurodollar spec bubbles ready to reverse

A look at long-term trends of commercial interest in the CFTC’s “Commitments of Traders” report. 

Spring brings new hopes. The commercial grain growers aren’t as optimistic. The year’s early rally has seen commercial producers jump into the market to sell their anticipated forward production. Farmers’ eagerness makes sense with the coming year’s expected global harvest to be record-setting, once again. Modern agronomy combined with increased global acreage finds the world filling its bins higher and higher at lower and lower prices. Perpetually declining prices have made growers exceptionally opportunistic in the placement of their forward hedges. 

The multi-year decline in grain prices isn’t over. The rallies in Chicago wheat, Kansas City wheat, soybeans and corn have all petered out near the 120-week moving average during the last few years. In fact, soybean meal has been the only grain market to buck the downward trend in grain prices. The record-setting speculative position in soybean meal leaves it as the most vulnerable of the grains to a washout. Speculators are now long nearly seven contracts for every short in the soybean meal futures. Barring a weather event, the commercial grain growers will halt any meaningful rally. This should be the year that grain prices decline dramatically with soybean meal back below $300 per ton, December corn near $3 per bushel and wheat near $4 per bushel.

The speculative bubble brewing in the grains, specifically soybean meal, leads us to the divergent behavior between the speculators’ record positions after the 10% decline in the stock market and the 13% decline in crude oil. A significant reversion to neutral of both the speculative and commercial positions can confirm a meaningful shakeout. 

Market turns, on the other hand, are also characterized by a growing commercial position, adding pressure to the already spooked speculators. Markets that have experienced a shakeout can then begin anew as the next round of price discovery sets up. This is what happened with the stock market sell-off. The speculative position in the E-mini S&P 500 futures declined by more than 60% as the market fell by 10%. Conversely, the speculative position only decreased by 4% as crude dropped by 13%. This strongly suggests that the crude oil bulls are still bullish, and will need more than the 13% decline it recently experienced to frighten the emboldened speculative bid. 

Finally, the record-setting commercial bid in the Eurodollar interest rate market must be addressed. Eurodollar futures are the most liquid contract in the world. They represent the interest paid on U.S. dollars deposited on foreign soil. The interest rate being paid can be calculated by subtracting the price of the Eurodollar Index from 100. The December 2019 contract is already the front month because it has the most open interest: more than two million contracts as of this writing. The current price of 97.11 indicates the interest to be paid on these deposits is 2.89%. Total open interest in the Eurodollar market has a face value of more than $1 trillion. The commercial traders set a record net long position through March and April of last year. This led to the September 2017 high where they offset about half of their position. The market has since fallen below the post-election sell-off lows. 

The commercial traders increased their net long position by 40% between Jan. 5 and March 5 in response to the recent wave of selling. They are now net long 1.66 contracts for every short. This is setting the stage for a sharp reversal higher to knock out the speculators and provide the commercial traders with an opportunity to reverse their position and get in line with the Fed’s long-term plans.