Eurodollar option - Open interest switching to lower strikes

Where is the mass of expectations? Look at the change in option open interest for a good idea. Here is the change in open interest during the last week for December eurodollar option on futures strikes. There has been a significant increase in put open interest for lower strikes with some lifting of positions of higher strikes. 

We have not provided alternative expirations, but this does suggest the direction of option trader focus. For the end of the year, there is a strong expectation that rates are going higher than the closing futures contract at 97.16. Higher inflation and talk of 50 bps increases is leading some traders to think that moves in 2022 will be greater than expected. 

The heavy hand of dealers and managed money (commitment of traders) in futures trading

The commitment of traders report provides useful information on who are the longs and shorts in futures trading and whether a trade is getting crowded. A quick review over the last three years tells a story on who is driving the markets. The difference in the commitment of traders across markets and through time can be substantial. 

We will highlight three markets to give a taste of the difference and where are the pressure points.

Corn - There is a strong money manager and dealer component to positioning, and it is net long. The flow of money manager money over the last three years is substantial as measured by the percentage of open interest. Producers have increased their net short positions.

Crude oil - This is not as sensitive to money managers and dealer exposures. There is no crowded trade in this market when comparing percentage of open interest over the last three years. 

Stock index - The levered funds have added to their short exposures this week, but their overall percent of open interest is stable at just under 15 percent. 

Equity opportunities in sector and country exposures

 

The risky asset was the safe asset for March as fixed income offered no protection from an inflationary and war environment, yet the rally in the second half of March may not continue if fears of a recession rise. Earnings have been robust and are extrapolated to continue, but the impact of an energy shock, less fiscal stimulus and general inflation will take toll on markets.

Duration risk is evident in most fixed income ETFs. Credit markets are suffering from duration and spread risk. The Fed tightening is spilling over to the international markets. The negative rates of yesterday are offering no cushion against higher global inflation.

The energy sector was outstanding for the first quarter; however, several sectors provided positive returns for March.

The commodity countries, Australia, Canada, and Brazil, prove to be strong places of value. The improved terms of trade and strong current accounts made these countries good places to store value.

Commodities up, bonds down, and stocks mixed - An inflationary war environment

The choice when faced with inflation war and inflation. The choice when faced with a lingering demand shock and now a supply shock. The old tried and true method is to hold bonds. Bonds have been the great diversifier for decades, but the world has changed. The safe asset is now the risky asset. The risky asset is now a safe asset. The non-traditional asset, commodities, is now a core asset. This switch started before the Ukraine War. The sanction world is just an add-on to the existing new inflationary world.  

There may be mean reversion in the second quarter from the extremes, but that may only be a temporary reprieve from an inflationary world that is far from transitory. With the Fed expecting inflation to be 4.3 percent for 2022, fixed income will need further adjustment. Yet, the growing possibility leaves us in a stagflation world that makes any investment choice more difficult. Thus, the risky asset of yesterday may be a safe asset tomorrow.