Yesterday, when discussing the VaR shock hammering rates traders over the past 48 hours as a result of the surge in short-term rates as one after another central bank capitulates to the rising global inflation wave, we excerpted from a recent analysis by Nomura's Charlie McElligott who noted that the flattening push will only accelerate as short-end traders are stopped out of their existing positions.
One day later, the latest Eurodollar data confirms that the carnage indeed surged as open interest in front-month eurodollar futures in preliminary CME data for Thursday suggests that many traders were stopped out of positions as shifting expectations for Fed rate increases repriced the market.
According to Bloomberg's Edward Bollingbroke, the net change in white-pack (Dec21-Sep22) eurodollar futures was -113,546 contracts, while open interest plunged -84,014 in red-pack futures (Dec22-Sep23). Open interest dropped 27,212 and 64,213 respectively in Dec23 and Dec24 contracts following a cluster of EDZ3/EDZ4 flattener trades, executed via blocks and totaling 35,000 on the day; the OI drop suggests the trades were done to exit steepeners.
The changes amounted to a 7.7% drop in total open interest for EDZ4, 2.3% for EDZ3.
The violent puke comes as the EDZ3/EDZ4 spread has flattened around 10bp from 30bp since Wednesday as prior steepening bets looked for rate-hike premium between these tenors to increase.
What does this mean practically? Well, the weakness in eurodollar futures, which set in following the raft of U.S. data at 8:30 a.m. ET, has seen rate hike odds jump for 2022 and 2023, and the market is now pricing in odds of a June rate hike as high as 87% - or around 22 bps - based on overnight swaps data.
Meanwhile, as traders pull liftoff odds ever closer, they are becoming increasingly skeptical that the Fed will hike rates as far as it has forecast, and as such the market-implied slope of the Fed’s path continues to ease. Its peak suggests five to six hikes by the end of 2025 to a level more than 100 basis points short of Fed policy makers’ projection.
This is remarkable as even the Fed's aggressive tapering schedule does not see the Fed ending its QE until June; for the central bank to hike the same month as it ends QE suggests that inflation will have to be scroching hot in mid-2022 for the Fed to reverse so quickly and commence effective tightening the same month as it ends QE.
At this rate the Fed, like the ECB, will soon lose control of the front rate as the market is telegraphing in no uncertain terms that Powell and Co are well behind the curve.