Eurodollar Spread Bets Heat Up Before Payrolls: Liquidity Watch

(Bloomberg) -- Traders are piling into interest rate bets in the Eurodollar market ahead of Friday’s payroll report.

Wagers on the spread between December 2022 and December 2024 Eurodollar futures -- a play on how the rate-hike cycle will evolve over that period -- have surged in popularity this week. On Friday, Morgan Stanley strategists argued the spread could widen on both better- and worse-than-expected jobs data.

The new recommendation ignited a burst of trading in the spread, though the direction of trades has been mixed, showing there is appetite to bet both on the spread to widen -- a so-called steepener -- as well as to narrow.

Appetite for the wager emerged for a third consecutive session on Wednesday, skewed toward buying the December 2024 contract vs. selling the December 2022 -- or a flattener position. Total volumes on the session in the spread are up to almost 13,000 as of 8:30am New York.

Volumes on Monday and Tuesday jumped to almost 60,000 contracts combined, well above the six-month daily average of about 2,000. Dealers saw two block trades of 5,000 contracts each, which helped generate the largest two-day activity since the peak of pandemic-driven market chaos in March 2020.

For the Morgan Stanley strategists including Guneet Dhingra, a disconnect has opened up between the pace and timing of Federal Reserve rate hikes after its June meeting. That has created an opportunity for investors ahead of the upcoming employment data.

“If economic data comes in strong, the Dec. 2022-2024 curve will steepen, led by the Dec. 24 contract, as the market prices in a faster pace of hikes,” the team wrote. “If economic data is weak, the Dec. 2022 contract can rally strongly, as the first order for the market will be to price out the aggressive path from tapering through to the first rate hike.”

The spread between the contracts is slightly tighter on the week and traded at 104 basis points on Wednesday.

Recommend Eurodollar Dec. 2022/2024 Steepeners: Morgan Stanley

A look at swap markets shows traders expect the bulk of potential rate hikes to come between the end of 2022 and 2024 -- the window of the spread trade.

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