Minyan Mailbag - "The Greenspan Hedge"
Note: Our goal in Minyanville is to remove intimidation from the financial markets and encourage an interactive dialogue among the Minyanship. We share this next discussion with that very intent.
In a speech given in Germany last year Greenspan said "Rising interest rates have been advertised so long and in so many places that anyone who has not appropriately hedged his position by now, obviously, is desirous of losing money." I believe I have seen this quote in dozens of articles over the last couple months.
On the surface this sounds rather brilliant and so everyone is now properly hedged, possibly by piling into Eurodollar and Treasury shorts. But if it is so brilliant how can there be anyone on the other side of the trade? In Greenspan's perfect derivative world are there no losers? Has everyone offloaded U.S. interest rate risk to Mars, Pluto, and France? That seems to be the common wisdom these days as if there is no relevant counter party to, "The Greenspan Hedge".
Enquiring Minyans do not easily fall for such logic. Let's see if we can gather some clues from the latest Commitment of Traders Report (COTs) Eurodollars Report. For Minyans not familiar with Eurodollars, they are an interest rate play NOT a bet on Euros. Here is a simple definition of Eurodollars, the key point being they are an interest rate play on U.S.$.
The commitment of traders report is here:
The non-commercials, a.k.a. (big specs, mutual funds, hedge funds etc) are 626,946 contracts net short. This figure is arrived at by netting 1,196,512 short contracts and 569,566 long contracts.
The non-reportables a.k.a. (small specs, individual traders) are 301,379 contracts net short. That figure is arrived at by netting 759,219 short contracts and 457,840 long contracts.
As most Minyans probably expected, it seems that interest rate risk has not been offloaded to Pluto, Mars, and France but sits right there on the hands of commercial traders who are net long 928,325 eurodollar futures.
By the way, these numbers are about as extreme as I have seen. They are nearly the exact reversal of last March when treasury rates shot to the moon over a 3 month period and Eurodollars were crucified in a 200 point plunge.
In this writer's opinion, small spec traders are rarely correct when they keep piling into bigger and bigger positions as commercials take the opposite side. Recent violent corrections in silver and gold are supportive of this conclusion. It now seems that the only concern on the hands of the big and small specs is now how fast Greenspan hikes not whether or not he is going to do it. With rate hikes priced in for February, March, and May, on top of the 5 hikes we have already seen, it appears to me that players are getting more and more aggressive shorting Eurodollars in the face of an economy that is clearly struggling. IMO everyone is ignoring Greenspan's past history of adding liquidity at the first sign of a problem. People also seem to be forgetting that Greenspan has been wrong at every major economic turn as well. Finally, anyone that attempted "The Greenspan Hedge" by shorting long term treasuries has been crucified lately as 10 yr treasuries have been in a long broad rally pretty much since last June.
Given the extreme negative sentiment on Eurodollars, there can easily be panic short covering if Greenspan pauses unexpectedly. In fact, it is so one sided, there might be panic short covering even if Greenspan attempts to give a hint of a policy change (aka "Data Driven" hikes as opposed to "measured hikes").
Some Minyans just might want to look at a chart or two.
Here is the JUN 06 ED contract.
There appears to be 5 waves up since the June bottom and perhaps we just finished a 3 wave corrective pattern down. The Fibonacci retrace levels from the May 2004 low are: 38.2% @ 96.06, 50% @ 95.89, and the 61.8% @ 95.71. You can see that the recent low in the 3 wave decline was at 96, which is the 38.2% retrace. This also supports the 5 wave advance - 3 wave correction count. There is also a momentum divergence with the recent low in that the decline has lost momentum. This is what one would expect to see with a correction.
The consolidation from the 2003 high on the weekly chart seems corrective. Since I am by no means an ewave expert (in fact a pattern has to pretty obvious for me to spot it such as the 3 waves down listed above) I asked for a second opinion from my friend Brian who is a lot better at seeing these things than I am. He offered this opinion for Minyans to consider: "I would probably count it as a 3 wave decline from the 2003 high, with the advance from the May 2004 low (shown on the Daily chart above) as the first move of the next major leg up. The fact that the 3'rd wave down of that large correction (that bottomed in May 2004) did not reach as low as the first corrective wave suggests the trend remains strongly up. It could also be a triangle, but either way the count is bullish. The down-trendline from the 2003 high connecting the subsequent highs is very clear. Just eyeballing it, it looks like a break above 96.5 would eventually lead to a rally beyond the 2003 high. Bottom line: the weekly chart looks bullish."
Perhaps professor Reamer has a comment on those charts as well.
For additional evidence, consider a chart of 10 year treasury notes:
As one can plainly see, the long term trend line towards lower yields on treasuries has still not been broken! Is there anything about that chart that suggests a short?
Enquiring Minyans do not give up so easily and might want to consider fundamentals and other factors. It just so happens there is still more evidence to consider.
As far as rate hike cycles go this one is getting reasonably long in the tooth. Only 4 times in history has the FED hiked 6 times in a row without a pause. I am counting the February hike as a given. The UK managed just 5 hikes in its tightening cycle before housing began to collapse. The next move in rates in the UK is likely down. Often times we follow the UK housing cycle with a lag.
Housing in the U.S. appears to be slowing, manufacturing appears to be slowing, and jobs have been stagnant for months. Mass layoffs are still coming in on the hot side and the long bond is hinting at recession. If housing collapses or job growth collapses I doubt that Greenspan keeps hiking as advertised.
Here is the latest Philly Fed report: Philadelphia Fed Says Factories Slowing
Factory activity in the U.S. Mid-Atlantic region expanded for a 20th straight month in January but at the slowest pace in 18 months, a survey showed on Thursday. The Philadelphia Federal Reserve (news - web sites)'s business activity index fell to 13.2 in January from 25.4 in December, marking the 20th consecutive month of expansion for factories in the highly industrialized mid-Atlantic region of the United States.
But the January reading was the lowest in 18 months, and far lower than the 26.4 median forecast by economists. The new orders component, a pointer to future growth, fell for the fourth month, to 9.8 in January from 20.9 in December. Mike Trebing, an analyst at the Philadelphia Fed, noted that while the new orders index has been falling, it was still positive. "We still had growth, but not as strong growth," he said, adding, "We have had declines like this before but the numbers bounced back the next month."
When was the last time new orders declined 4 months in a row?
One more month like this and new orders will be contracting.
When was the last time new orders turned up after 6 rate hikes?
I am willing to bet never.
Is everyone in denial about the slowing? I think so, especially given the lagging effect on the economy of repeated interest rate hikes.
"We have had declines like this before but the numbers bounced back the next month."
In this Minyan's opinion, the extreme sentiment against U.S. interest rate futures, poor stock market action, excellent action in the long bond, corrective wave patterns on Eurodollar charts, bullish looking 10-yr treasury charts, as well as a load of evidence that the world's economy is slowing all point to a pause in this rate hiking cycle, perhaps even a reversal if housing really takes a dive. The next hike is probably a given. I doubt we see too many more. Obviously this is my opinion and not advice.
Minyan Mike Shedlock
Todd Harrison is the founder and Chief Executive Officer of Minyanville. Prior to his current role, Mr. Harrison was President and head trader at a $400 million dollar New York-based hedge fund. Todd welcomes your comments and/or feedback at firstname.lastname@example.org.
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