By Edward Bolingbroke
(Bloomberg) --The clock is ticking for bond traders still looking to scoop up cheap bets on a more hawkish Federal Reserve.
While the eurodollar futures, fed fund futures and overnight index swap markets have almost fully priced in the Fed’s forecast of three hikes this year, they’ve been, until recently, stubbornly dovish on the pace of rate increases beyond 2018. The spread between December 2018 and 2019 eurodollar contracts is pricing in just 35 basis points of tightening next year, and only 13 basis points for 2020.
The benign path of expected rate hikes over the two-year horizon stands in stark contrast to the backdrop of a weaker dollar, tax cuts and a potential surge in infrastructure spending. Traders have started to catch on. Demand in the eurodollar market has slowly begun to emerge for downside hedges -- or protection against a more aggressive policy path -- across the 2019 and 2020 tenors. A flurry of steepener trades, some immediately after Wednesday’s Fed meeting, are betting on front-end spreads to widen. The gap between December-18 and December-19 contracts has almost doubled since the start of the year.
Subtle tweaks in the language of this week’s Fed policy statement may be fueling the wagers, according to Goldman Sachs Group Inc. Chief Economist Jan Hatzius.
“While further rate increases were already implied by the previous wording – and by the hikes projected in the December summary of economic projections – we think the committee implemented this change to emphasize the durability of the hiking cycle they foresee,” Hatzius wrote in a Wednesday note to clients.
Other strategists are now warning of an upward revision to the Fed’s longer-term rate projections next month.
The steepening move in the eurodollar market is matched by a 22 percent climb in open interest in December-18 futures and a 39 percent rise in December-19 futures since the start of the year. Thursday saw volume on spread trades between the two surge to the second-highest on record. In the options space, new hawkish bets are being lined up for 2019, while existing downside hedges are increasingly being pushed further out the eurodollar strip.
Traders are wagering the strip will continue its post-FOMC bear steepening, with the red (2019), green (2020) and blue (2021) packs significantly underperforming the front-end white packs.
To contact the reporter on this story: Edward Bolingbroke in New York at [email protected] To contact the editors responsible for this story: Benjamin Purvis at [email protected] Boris Korby, Mark Tannenbaum