Money Market Derivatives Surge as Fed Rate Increases Pushed Out

Money market derivatives are rallying as traders push out expectations for when the Federal Reserve will begin to raise interest rates next year.

The implied yield on the December 2015 Eurodollar contract reached as low as 0.86 percent, the lowest since May 29, and down from 1.11 percent at the end of last month. Projections in the market for where rates will be two years later, in December 2017, slid to 2.5 percent, from as high last month as 3.02 percent. Rates on federal fund futures signal traders predict the U.S. central bank will increase its almost-zero target rate during September 2015, compared to above 50 percent odds two months ago of a July 2015 hike.

“Everyone is on the lower-for-longer train again,” Jim Lee, head of U.S. derivatives strategy at Royal Bank of Scotland Group Plc’s capital markets unit in Stamford, Connecticut, said in a telephone interview. “People now think the Fed is clearly worried about external factors like Germany slowing down and the strong dollar being detrimental to U.S. exports. There is room for further capitulation.”

Minutes released yesterday from the Fed’s previous policy meeting took speculators by surprise by revealing that the central bank is wary of weakening global growth and the strong dollar. A number of participants at the meeting said growth “might be slower than expected if foreign economic growth came in weaker than anticipated,” according to minutes of the Sept. 16-17 meeting.

Accumulated Wagers

Eurodollars, the world’s most actively traded futures contracts, trade in price terms for an implied yield calculated by subtracting the price from 100. The contracts settle at expiration to the three-month dollar London interbank offered rate and their movements before maturity are based in part by expectations for Fed interest rate policy. Falling contract prices show rising implied yields.

The average yield on what is known as the red pack, presently representing the quarterly Eurodollar contracts maturing from December 2015 through September 2016, is at 1.29 percent, down from as high this year of 1.52 on Sept. 30. The average on this strip of contracts is the lowest since Sept. 12.

Leveraged funds, which typically use borrowed money to boost returns, held record net accumulated wagers for declines in prices of CME Group Inc.’s interest rates derivatives, ranging from the Eurodollars to the ultra-long Treasury futures, at a value of $92.1 billion as of Sept. 30, when measured in the equivalent value of 10-year Treasury notes, according to calculations by Lee using Commodity Futures Trading Commission data.

The net short wagers in all Eurodollar contracts, reached 1.5 million contracts as of Sept. 9, according to CFCT data tracked by Bloomberg. The level fell to 1.3 as of last week.

“These shorts are being squeezed,” said Lee.

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