Eurodollar Time Evolution And QE/ZIRP Expectations
Sticking with the history of the “dollar” of these past two years, economists and gold de-buggers had to have been at least initially encouraged by what they saw outwardly of interest rates and related financial factors in 2013. Almost as soon as “taper” became a mainstream concept, right at the start of that May, the treasury curve steepened and nominal rates rose – exactly what you would expect in a full recovery. And, of course, gold prices had already collapsed which was simply lumped all together.
Yet, despite those outward appearances, there were strains already evident beneath the surface that indicated that much was uneasy about the whole anticipated transition. Swap spreads, which had been “inverted” with the 10-year spread at zero or even negative here and there, departed from the QE3/4 fixation as early as February; that suggested dealer backlog on collateral positions (they had been taking floating in what sure looks to be extreme positions in that direction, and then suddenly the possibility of being crowded on the “wrong” side of even suggestions of QE being far less than semi-permanent triggered collateral repositioning and a wholesale recalculation of risk and balance sheet factors). Repo rates dropped negative (preponderance of specials) that March and then again, which even triggered, only three months into QE4, the Open Market Desk openly (pun intended) altering its QE mechanics.
Given that unstable and really unsuitable capacity setup, the fact that the euphoria over central banking prowess only lasted to early September (in wholesale markets, anyway) isn’t all that surprising. Eventually, rate markets began to see what gold (and repo, and swaps, etc.) had essentially predicted months prior – “something” was wrong with the “exit strategy” because the global economy had clearly slowed and was actually breaking apart, if only in minor fractures then, in various places. That was further emphasized on November 20, 2013, when some still unknown event triggered a systemic and heavily bearish reversal in credit that remains to this day.
What I maintain from that is markets were sharply awoken to the irregularities that existed where they were supposed to have been at least suppressed if not forthrightly banished. The bearish trend from that point was under that view whereby the Fed’s opposite narrative was only received as an intention to make it all much, much worse.
Viewing the eurodollar curve, specifically, I think you get a rather plain sense of it. The calendar roll of eurodollar futures, time is a major component of this kind of chained-liability “money”, obscures this trajectory but equalizing the time factor brings it into rather easy observation (I anchor the eurodollar curves below on the June futures maturity for ease in comparison only).
The chart immediately above shows the “happy” economists, as the eurodollar curve took to steepening very broadly and very sharply, at first. It, again, only lasted just over four months as by early September 2013 the curve would find its most recovery-friendly interpretation. It was all downhill from there.
What I think is most important in this comparison is how the shorter maturities have sharply risen as the (potential) “exit” point has grown steadily closer and what that has done to the back end. In other words, as the shorter end rises up in anticipation of the Fed’s raising rates (generically, there are further complications about how they might actually be able to do it, or not be able to do it, which are certainly a part of this doubtful curve narrowness all along) the bank end and even the middle 3-5 year section has dropped and flattened. You can make a couple of interpretations about that, but I think the broader context of “dollar” behavior and evidence these past two years are strikingly consistent about what that means of market expectations: the Fed’s tightening will only make a bad situation worse.
That point is further emphasized by comparing the structure of the eurodollar futures curve on May 1, 2013, to some more recent and “doubtful” curves. Clearly, the short end shows a much, much greater expectation for higher short-term rates on the flow of time alone. The flatness of 3-years and out stands out in what is really a rejection of what is “supposed” to be happening by then. The curve from May 2013 is thus far more hopeful than what we see now, even though it was a snapshot of expectations at a point when there were still (rightfully) tremendous doubts about not just the economy but also what QE3 and QE4 might do in and around it.
In a more narrow sense, the eurodollar curve has over these two years acted out what gold was suggesting when it was slammed concurrent to that May 2013 curve. Systemic liquidity has only grown worse, as has global and domestic economic reality. Economists remained giddy until only recently, whereas credit and wholesale funding picked up that warning after only a few months’ time.