Stop Reached On EUR

Yesterday, the long position in Dec14/Dec15/Dec16 fly reached the stop at -62bp.

We have encountered an average loss on the full position of 14bp, as we had a first entry at -42bp on 29 October and second entry at -54bp on 17 December.

The market has increasingly bought into the Fed's forward guidance, which has hit the fly. However, the fly still looks too cheap relative to the FOMC's estimates.

Update on 1Y2Y SEK-EUR: move stop to 100bp (see more information on page two of the document).

The rationale behind the trade was that the belly of the fly was too rich relative to the wings and that the position would perform in scenarios where rates were higher or lower.

When the position was opened at -42bp on 28 October 2013, we estimated that the median Fed forecast on year-end fed funds rates, was consistent with a fair value of the fly being around -5bp. With our target of -20bp, we believed at that time that there was scope for the fly to correct some of the way towards this level.

Since the trade was opened, short-end rates have moved lower but Dec15/Dec16 has remained very steep as data has improved. However, the Dec14/Dec15 has flattened as the Fed has successfully managed to guide low for longer despite tapering drawing closer. In combination, this was negative for the trade and the stop was reached.

Following yesterday’s FOMC meeting our estimate of a fair level has declined to -30bp from -5bp. However, the market is now trading around -58bp. Relative to the Fed guidance, the market is pricing a longer period of rates at the current level followed by a period of more aggressive hiking than implied by the Fed forecast.

Hence, even with the Federal Reserve’s updated year-end forecast on interest rates, we still believe that the kink in the money market curve is too pronounced.

To Read the Entire Report Please Click on the pdf File Below.