U.S. ten dollar bills and ten euro banknotes are arranged for a photograph in London, U.K. (Photographer: Simon Dawson/Bloomberg)

Eurodollar Whale Betting on Fed Rates Looks Well Beyond December

(Bloomberg) -- It looks as though there’s a new eurodollar options whale in town who doesn’t care whether the Federal Reserve raises rates in December. With the market assigning near-even odds to a fourth rate increase in 2018, the newly popular wager is on where the benchmark rate will come to rest well beyond that.

A massive position appears to have been built by an investor (and potentially some copycats too) in eurodollar options whose value is linked to the federal funds target from September 2020 until mid-2021. Forward markets are pricing in a rate of 2.65 percent by mid-2020 -- two more rate hikes and a better-than-not chance of a third after this year. The eurodollar position is a bet that the rate won’t get into the 4 percent to 4.25 percent range.

That may seem like a sure bet, but if it turns out to be wrong, the position in ratio put spreads will incur steep losses.

It started to grow in July, via sales of puts expiring from March 2019 to September 2021. On July 27 alone, open interest in the December 2020 95.875 put increased by 84,000, more than half of the aggregate open interest in the strike at the time.

At the same time, eurodollar options traders are becoming increasingly uneasy about making bets on December. That was highlighted Thursday via several large trades of a low-risk put condor consistent with liquidation at a loss.

Eurodollar Whale Betting on Fed Rates Looks Well Beyond December

Minutes of Fed policy makers’ Aug. 1 meeting, released Wednesday, included discussion of the policy toolkit and the potential limits on policy effectiveness stemming from the effective lower bound. That’s cold comfort to traders hoping for more clarity on December. Adding to the conundrum, the options expire two days before the Federal Open Market Committee’s Dec. 19 policy announcement.

Risks to December eurodollar positions also include the possibility of another tweak to the interest on excess reserves rate, which acts as a cap on fed funds and was raised by just 20 basis points in June. Wednesday’s FOMC minutes showed Chairman Jerome Powell -- slated to discuss monetary policy at the Fed’s Jackson Hole symposium at 10 a.m. New York time Friday -- said discussion of operating frameworks would resume in the fall, and Bank of America strategist Mark Cabana this week predicted a second IOER adjustment by December.

Factor in President Donald Trump’s commentary on Fed policy, the emerging impact of trade protectionism, the prospect of yield curve inversion and falling expectations for Libor relative to overnight indexed swaps. It’s no wonder anyone would decide that calling a settlement price on December eurodollars is for the birds.

©2018 Bloomberg L.P.