Booking Expectations

The addition of the newest office member has added an exponential increase in our trade idea generation. Though we have been substantially quiet in many of our markets, it hasn't been for lack of ideas, rather we're experiencing a total lack of conviction. As I type now we're in the midst of another spectacular bull session for the Euros. LIBOR has downticked to a paltry .28906%. In the last 15 trading days, the Green December ED {2012}has rally almost 40 ticks. The expectations of long term QE are all but assumed to be relevant from now through the 2012 calendar.

We're stuck with the questions of how profit in the zero interest rate vacuum. How do craft an option play that capitalizes on the market's perceived risks {that the market continues to drift toward zero? Over the past few days large ED customers have been buying thousands of EZ2 9925 calls at 1 {>30K}as well as the EZ2 9900-9925 call spreads at 4.5 and 5 {>40K}. Seriously!?! That's 40 ticks away and has 65 days til expiration. That's unbelievable. Though given the the last 15 days, it doesn't seem like much of a stretch huh?

Now we're drifting higher in price, lower in yield. The markets can't keep rocking higher, can they? What happens when QE2 gets released?

One of the more poignant arguments I've stumbled across lately is in a Bianco research piece. This piece focused on the amount of QE2 and hinges off of a Bill Dudley speech recently given to the Society of American Business Editors and Writers. Dudley stated that "$500 billion of purchases would provide about as much stimulus as a reduction ion the federal funds rate of between half a point and three quarters of a point." They then surmised that Dudley reached this conclusion by using the Taylor Rule to approximate a neutral funds rate.

"Using core PCE as a measure of inflation, the Taylor Rule places the neutral funds rate at -1.50%...With the fed funds rate essentially at 0%, the Federal Reserve has used asset purchases as a means to further decrease rates. These purchases have created almost $1 trillion in excess reserves as of 9/22. Taking Dudley's statement at face value, $1 trillion in excess reserves has already pushed the "implied funds rate" to somewhere between -1.00% and -1.50%. A further $500 billion in QE would push the rate to somewhere between -1.50% and -2.25%." {http://www.arborresearch.com/biancoresearch/}

Ouch, especially for our market. Maybe the large ED customers have read this idea too and are hedging best they can. Can you actually get negative interest rates?

~LH