Nic Lenoir Twofer - A Look At The Market, Front ED Contracts And LIBOR
Some market commentary first from Nic Lenoir of ICAP:
Following up on yesterday's comments: equities are so far unbelievably resilient in the face of atrocious economic data. Keeping our eyes on the prize, we have been calling for this slow down in economic activity since April, and the work of my friends Julian Brigden and Jonas Thulin on the economic roll over has helped solidify that belief and time this turn. Now that the data is playing ball and confirming our sentiment, we turn to the technical picture where I have had this uneasy feeling that the equity markets could bounce here before selling off properly. With higher rates for European sovereign bonds today after Ireland's downgrade, all time lows in new home sales on the heels of a knock-out drop in existing home sales that will dry up your green shoots and make you wish it's just a double dip, and a huge miss in durable goods orders, the fact we just made it in positive territory back from the abyss this morning is the kind of price action that makes me feel better about yesterday's technical observations against our bearish fundamental outlook.
We extend these observations for equities to US treasury futures today. The attached charts show a possible complete impulse, and at least on the 3-hour chart these recent highs come along with a quite a bit of divergence and a rejection of the channel resistance. I see at the very minimum 125-07 tested, and more likely a test of the channel support currently around 123-28. Then if my Elliott Wave analysis is accurate that this impulse is complete, the target on the downside becomes 122-06. My view for equities coincides with a strong USD and lower yields, but for the near term the technical picture is resolutely bearish and this is supported by our observation for other asset classes. This is also comforting to note that volumes in Fixed Income are very high today and there is a lot activity both in options and futures space. This morning's analysis of EDZ0 flows highlighting that no profit taking had taken place as of yet and that weakness was driven by fresh shorts expressed via options is completely validated by over 510K contracts traded today already when Monday at the same time of the day we had not breached 100K for any of the contracts of the strip...
And a Look at Front ED Contracts and LIBOR
We have recently recommended selling EDZ0 against buying ERZ0. Our rationale was both a technical trading observation of the spread, cross-currency funding considerations between the futures' spread and the EURUSD currency pair, and risk reward with Libor rates being so low that the upside of longs is relatively small. Subsequently the trade has benefited greatly of the sell-off in front Eurodollar contracts this past couple days. Yesterday morning the 99.50/99.25 put spread on EDZ0 traded as low as 2 basis points, and we felt that was resolutely too cheap. Sure enough they were trading 4 earlier this morning.
With the large flows observed yesterday in Eurodollar options, my colleague Mike Lawrence and I decided to look into open interests. A fact that immediately grabbed our attention is that EDZ0's open interest went up the past 2 days instead of down when compared to the two previous sell-offs for the contract in November 2009 and April/May 2010. That meant what we were looking at was not profit taking. So we summed up all the flows for strikes 99.00 or above for both EDZ0 and EDH1 and weighted the change in open interest for puts and calls using the options' delta. The results are attached for those who want to look at things at the strike level, but basically the conclusion is that the large increase in open interest for puts concurrent to lower open interest for calls equates to 80,000 fresh shorts in futures. This is something the market must digest and it is no surprise the market is under pressure today again, especially if you start factoring in gamma considerations.
We also heard from money markets traders that while CP rates were still trading inside Libor yesterday, the rush by money funds to chase yield no matter how dismal has abated. These money flows reinforce the thought that risk reward, whether it's from lending at these levels or holding Eurodollar long positions is tilted towards higher rates.
Good luck trading,