Yesterday afternoon at around 1450ET, someone placed a huge 10,750 contract bet on the eurodollar strip - hoping that Janet Yellen will flip-flop back to her hawkish side and reignite expectations for a faster pace of interest-rate increases when she speaks tomorrow in Jackson Hole.
The notional size of this trade is almost $11 billion. The last time such a huge bet was placed was into the US election in November.
As Bloomberg reports, the steepening trade looks to cash in on the eurodollar strip being close to the flattest levels of the year, reflecting odds of a December rate hike recently dropping to just 30 percent based on OIS.
Open interest, or the amount of new risk, jumped 10 percent in the December 2020 eurodollar futures, according to CME data, reflecting the new position.
While this trader seems convinced a surprise is coming, most sell-side shops see tomorrow as more of the same snoozefest. As we detailed previously, Deutsche Bank's strategists noted that:
"in the US there is a tension between softer inflation and easy financial conditions and given the topic of Yellen's speech is 'financial stability' she may lean towards prioritising one side or the other.
Overall the market will probably be most sensitive as to whether a December hike is more or less likely after her comments. The imminent halting of reinvestment seems to be considered a fine deal."
And UBS is convinced that Friday's events will be a snooze fest? Here is the explanation
The FOMC has told us what they want us to know on monetary policy
The FOMC has increased its communication and transparency about the normalization of its balance sheet. The big news is out. The outlook for rate hikes, Chair Yellen and the FOMC have told us, depends on the realized and expected path of inflation. Some technical details about implementation remain to be disclosed, but Jackson Hole would not be the venue. The FOMC has also been clear that they will put off decisions on the terminal size of the balance sheet until after implementation has begun.
"Financial stability" matters, but isn't new
As we noted, the Minutes of the June and the July meetings both discussed financial stability issues. In July, "a number" of participants noted that very low long-term yields could snap back abruptly or induce excessive risk taking. Moreover, the FOMC discussed equity valuation as a possible source of financial instability along with commercial real estate. On net, however, the FOMC seems comfortable with current financial stability risks, even though they will continue to monitor developments.
So what will she say about financial stability?
We suspect that Chair Yellen will take this opportunity to discuss the distinction between financial stability considerations and financial conditions more broadly. She will take stock of the signal from historically low interest rates and the forces that determine those rates. These factors include slower potential GDP growth than historically was the case, global savings demand for very safe assets, and the Fed's balance sheet that continues to put some downward pressure on rates. She will note that equity valuations are high by some metrics, but by others may be justified. She will spend time on tight credit spreads, especially in the context of the Fed's monetary policy, the ongoing expansion, and generalized risk taking. Finally, she will acknowledge that parts of the Committee see commercial real estate as potentially pointing to excessive risk taking.
Well, what about financial conditions?
The Chair will take some time to differentiate financial conditions from financial stability concerns. The high level of equity prices, tight credit spreads, and low longer-term Treasury yields are much in discussion. She will note that the easy financial conditions are not, in and of themselves, a problem for monetary policy. Rather, they are one factor among many that inform her outlook for the economy. Easier financial conditions should, all else equal, support aggregate demand. In fact, as noted in Fedspeak, the Committee's outlook for ongoing gains and higher inflation over time is supported by these conditions, not hampered by them.
What should we take away?
Very little. Overall, Chair Yellen's speech will articulate more clearly how the FOMC thinks about financial stability issues, there should be very little that informs us on the near-term outlook for monetary policy. She will likely reiterate that the post-Crisis regulation has made the system safer. She will embrace the idea that there is room for some adjustment to the existing regulation, but she will push back against the idea of wholesale financial deregulation.
Mrs Yellen will be speaking Friday morning at 10AM EST on financial stability.
As usual, none of the conference speeches are broadcast. For all of the published speeches and papers, text will be released at the scheduled time for the panel or speech and there is no televised Q+A.