How to trade the Fed opening the door for a March rate cut
Chief Investment Officer
Summary: The fallout from the coronavirus will likely see the Fed downgrading its outlook for growth and waxing dovish on rates, which could see a sharp repricing of expectations for a Fed rate cut already in March. Such a move is far from priced in and could lead to very large moves in short term EuroDollar interest rate futures.
The coronavirus outbreak in China and the major disruptions it has caused will impact the growth outlook with the massive disruptions to travel and basic economic activity – think retail activity and simply the movement of people to and from work, etc.. - across vast swaths of China and as travel to and from China is vastly curtailed until the threat has peaked and ended, a process that could take a few months at best. The Powell Fed is not likely to miss the opportunity to raise concerns on the implications for US growth and especially the inflation outlook from this disruption and could open the door wide for a March rate cut. Eurodollar Futures traders are already pricing higher odds of a cut, but are far from pricing a March move.
Traders looking to trade a more dovish Fed can go long EuroDollar futures (3-month short-term interest rate – strictly speaking this tracks the Libor fixing, but that tracks US 3-month interest rates very closely), as the market has not yet priced in a full 25 basis point rate cut through the June meeting. If the Fed begins cutting again on concerns for the outlook, it could cut in both March and at least once more through the June meeting – actions that are not yet priced in the market. See more on the specific contract and levels below.
Trade: Long the June 2020 EuroDollar contract (GEM0) in 98.40 area, with a stop below 98.30 and a target of 98.75, trailing the stop by 20 ticks once the price exceeds 98.50.
Risk: The risk to this position is that the Fed fails to tilt as dovishly as we expect and sends the message that it would prefer to wait and see for now on interest rates in coming months, leaving to a higher rate expectation from the Fed and leading to a stop-out of the position.
Chart: June 2020 EuroDollar STIR future
Note that this recent rally has broken the late trendline and that if the market is to price a full rate cut and possibly two, the contract could reach new highs as the market prices a 1-1.25% Fed policy rate on the other side of the June meeting (post-June meeting expectations currently at about 1.45% vs. 1.625% currently)
Latest Market Insights
Quarterly Outlook Q2 2022: The End Game has arrived
- Shocks from covid and the war in Ukraine have forced the global financial and political world to change, but what will the end game be?
Productivity and innovation have never been more importantAs the world economy hits physical limits and central banks tighten their belts, could equities be facing a 10-15% downside?
The great EUR recovery and the difficulty of trading itIf the terrible fog of war hopefully lifts soon, the conditions are promising for the euro to reprice significantly higher.
Tight commodity markets – turbocharged by war and sanctionsWith supply already tight, commodities keep powering on. But will it last for yet another quarter?
Between a rock and a hard placeGeopolitical concerns will add upward price pressures and fears of slower growth, while volatility will remain elevated.
The Great ErosionInflation is everywhere and central banks try to combat it. But will they get it under control in time?
Australian investing: Six considerations amid triple Rs: rising rates, record inflation and likely recessionWhile global financial markets are struggling in an uncertain world, the commodity-heavy Australian ASX index is poised to keep a positive momentum.
Cybersecurity – the rush to catch up with realityWith the invasion of Ukraine, governments and private companies are rushing to reinforce their cyber defenses.
Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-gb/legal/disclaimer/saxo-disclaimer)