Eurodollar interest rate futures are easy to trade and are the most liquid futures market in the world, writes Paul Cretien.
Eurodollar futures are easy to trade and the volume of trading is usually high through intermediate maturities of four or five years. There has never been a better time to use this interest rate trading medium. Look at months from the September through December 2019 at this time, and then review further trades based on what happens in the United States and the rest of the world during the final months of 2019.
Eurodollar futures are based on a hypothetical $1 million deposit in a foreign bank. The futures contract price is equal to 100 less the short-term rate for a given month, and price changes are for a $1 million deposit for one-quarter of a year. This means that each basis point (100ths of one percent) is equal to a dollar price change of $25.
Four Reasons to Consider Eurodollars
1. Tariff wars and associated economic problems will lead to (and already have led to) problems for companies dependent on import and export pricing. As these problems continue and worsen it is likely that some action by the Federal Reserve may reduce short-term interest rates to assist the economy. Early this week an indication of this sort was hinted out by the Federal Reserve chairman and the stock market responded with a huge gain. The Fed usually reduces the shortest term rates that coincide with the most active Eurodollar maturities.
2. The yield curve is currently inverted, with short-term rates higher thanlong-term rates. An inverted yield curve is not normal and is likely to move toward a normal structure of interest rates and maturities over the remaining months of 2019. Look for short-term Eurodollar rates to fall for this reason.
3. The Eurodollar yield curve is too high relative to the U.S. Treasury yield curve.Historically, the Eurodollar yield curve (computed as a series of geometric means of rates leading up to a given maturities), has been virtually equal to the U.S. Treasury yield curve. The chart below shows the Eurodollar rates (black dots), the computed Eurodollar yield curve (red dots) and U.S. Treasury yields (blue triangles). Note the approximate 20 basis points spread between Eurodollar yields and U.S. Treasury yields. Reducing this yield difference would lead to a $500 gain for every Eurodollar futures.
4. Short-term Eurodollar rates will be the mechanism that pulls the Eurodollar yield curve into its proper relationship with U.S. Treasury yields. This will force the shorter-term Eurodollar rates even lower as they endeavor to lower the Eurodollar yield curve.
Barchart.com provides Eurodollar futures prices that may be used to compute the geometric mean Eurodollar yields. An Excel spreadsheet showing the calculations of Eurodollar rates and yields can be obtained at Cretien619@aol.com.
