There's a saying that's been around a looong time in the domestic interest rate and stock markets. Although it was once nearly forgotten, it's come back with a vengeance since the 2009 collapse. DON'T FIGHT THE FED. Ring a bell? The Federal Reserve Board (FRB) here in the US has been the leader in extricating the world's economy from the depths of despair. Their policies, whether right or wrong, have put us on the leading edge of the global economic landscape. Two things have happened as a result of this. First, the US now finds itself dragging along the global economy because the FRB's practices have placed the US ahead of the global recovery curve. Secondly, because we're now ahead of the global recovery curve, the first rate hike in years is being taken for granted as global pressure suggests the FRB may have acted too soon. The reality of this is the trade setup in the interest rate complex as shown below.
The FRB raised interest rates a quarter point on December 15th. The move was highly anticipated by the trading public and highly telegraphed by the FRB. Telegraphing the move was a strategic move by the Fed as it allowed the market to talk rates up and prices down ahead of the actual event. Notice particularly that commercial traders were aggressive buyers of the dramatic decline ahead of the FRB's announcement. In fact, they set their net long record position the same week the FRB acted. Coincidence? I think not. Look at the commercial traders' collective actions over the last two years in the 5-Year Treasury Note futures on the chart below. While this methodology didn't catch every move and has been known to be early on occasion, it did put us on the correct side of most of the meaningful rallies and declines. The commercial traders in the interest rate complex are some of the most connected, fundamental and quant oriented traders in the world. Therefore, we use them as a proxy for market bias.
This brings us to the current trading situation. As you can see on the chart below, commercial traders have been offloading the purchases they made ahead of the FRB's announcement on the recent rally. The fact that the CME Group's Fed futures are predicting an 82% (and growing) chance of another hike at the March 16th meeting clearly shows a disconnect between current market action and the FRB's long-term intentions. Furthermore, commercial trader selling on this rally has shifted their momentum to the sell side. When we combine negative commercial sentiment with an overbought futures market, we get the general setup for a Cot Sell Signal. We expect the interest rate sector to reverse hard from the new all-time highs being made in the face of commercial and FRB selling. We'll wait for the market turn prior to entering short positions. Once it does, we'll issue the appropriate sell signal along with a protective stop price. This will put us on the side of the big money and the macro trend.
