It’s been an interesting week in the interest rate sector. Three major developments have come into play. We’ve had the Federal Reserve Open Market Committee (FOMC) meeting; Goldman Sachs made a major recommendation and the gap between Commercial trader positions versus large trader positions have increased to the widest levels since the economic collapse of 2008.
The week started with my download of the Commitment of Trader data. Commercial traders have moved to a four-year high in their short position total while large traders appear to have taken the other side of this trade. Short positions in the interest rate sector profit when the price of the treasury issue declines. When treasury prices decline, yields rise. Commercial traders are taking the action necessary to profit from a move away from our historically low interest rates.
On Monday, Goldman Sachs came out with a sell recommendation in U.S. Treasuries. This clearly puts them in line with the opinion of the commercial trader. Francesco Garzarelli, Chief Interest Rate Strategist at Goldman argued that U.S. 10-year note yields would not be able to remain below 2% much longer. Goldman rarely comes out with outright trades in the futures market, which makes the plain language this strategy was laid out in all the more notable. Quoting Goldman’s trade, “Sell March 10 year futures contracts at 130.00 and risk them to 132.00 with a profit target of 126.00.” In English, they are selling 10-year treasuries about where they are now (130.00) and risking $2,000 per contract to make $4,000.
Part of the interest in Goldman’s recommendation is that it came out ahead of the FOMC meeting. The Fed left interest rates unchanged with the same target rate for Fed Funds of 0 to .25%. They generally believe that the U.S. labor market is improving and that inflation has moderated. Due to the early stages of our recovery and the expected European recession combined with slowdowns in India and China they plan to extend the exceptionally low rates through the late 2014. The final point to note is that going forward the Fed has instituted a new policy of a publicly stated inflation target. This is a first for the U.S. and puts them inline with other countries like England, Brazil, Canada, Australia and many others. This is also a publicly supported policy by the International Monetary Fund.
The current policy places the Federal Reserve Board at odds with the head trader at Goldman as well as the collective knowledge and resources of the traders representing the commercial trader category in the Commitment of Trader Reports. This is the interesting part of the story. One of the primary axioms of trading is, “Don’t fight the Fed.” Successful trading is all about money management and taking ego out of the equation. No one has more resources than the Fed and taking the other side of their trade can only be viewed as an ego fueled proposition.
I believe that any market shocks will send rates lower and prices higher. Eurozone crisis, Greek default, Middle East tensions and collapsing stock market would each, individually send yields lower on a flight to safety. We are on the precipice of these things happening in combinations. Therefore, I will be siding with the Fed and expecting rates to, not only remain low, but also plan on any surprise moves accelerating the markets’ move that direction as well.
This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.
