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Markets

Traders Are Already Pricing for When the Fed Starts Hiking Again

Traders Are Already Pricing for When the Fed Starts Hiking Again

  • Eurodollar curve shows market at odds with Federal Reserve
  • Wagers expect rate-cutting cycle to be aggressive but short
Premature to Price In Three Fed Cuts, Deutsche Bank's Reid Says

Eurodollar futures traders, having decided that the Federal Reserve is likely to cut the fed funds target range at least twice over the next six months, are looking beyond the expected easing cycle in search of their next edge -- the point at which rates will resume rising.

While Fed Chairman Jerome Powell and his colleagues have yet to signal that even one rate cut is forthcoming this year, the back end of the eurodollar strip is starting to re-steepen, pricing in a chance of rate hikes as soon as late 2020. One representation, the spread between the September 2020 and September 2021 eurodollar futures contracts, has returned to positive territory after being inverted for most of the past year.

Rate hike premium priced into eurodollar spreads late next year

One such forward-looking play appeared in the eurodollar futures market last week. A big bet on steepening of the curve from September 2019 to September 2020 built up over two sessions has gained more than $20 million in value. A sale of the structure Tuesday may have been profit-taking on the position.

The implied expectation is for a series of rate cuts beginning aggressively in July and ending this year. Barclays is in this camp. Last week its economists forecast a half-point cut in July followed by a quarter-point cut in September. And they may be late to the party: Gutsy traders were scooping up cheap upside options to hedge against such a dovish scenario back in May.

Overnight interest swaps, by contrast, assign 80 percent odds to a quarter-point cut in July, and fully price in two cuts and 30 percent of a third by the end of the year.