Sounds Easy – Isn’t

Here we revisit our primary theme from December for the road ahead - the bear flattener. As deferred Eurodollar contracts spiraled away from the gravitational pull of ZIRP last Spring, the stabilizing gambit of FG increased. The relationships between these contracts hit new forever wides in December as a general exodus of FI ended the year. In 2014, a general proxy for 5-30 (the green vs gold Eurodollar-consult The Eurodollar Futures and options handbook for why) has retreated to around the levels of the July/Oct "stability". The liquidation of shorts and the drop in data have allowed this to occur in the "bullish" (lower rates) cover.

We continue to believe the nasty adjustment coming in the curve will be the bearish flattening kind. Positioning for this adjustment sounds easy, but proves difficult. Carry and roll demand timing to be precise. The Fed's FG policy exists to keep this action under wraps. The Minutes showed the Yellen Fed is oriented toward the return to a Rates Regime and that orientation will push back against the FG "shock absorber."

The bottom line is beyond a 1 year horizon "the belly" has little value as we price it. The ownership of the longer dated is merely to help finance our disdain for the 3 to 6 year sector. The activities that produced relationships of this magnitude were historic. FG and Tapering are shallow tools to combat the natural forces they were designed to mitigate. We believe the adjustment inward (if/when it occurs) will be historic also.


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