Last week I suggested that Five year yields would decline from 1.725. On Tuesday, the yield had declined to 1.535. The specific trade I suggested was to buy FVH 118.75/119.75 call spread for 19/64’s. It settled yesterday at 38/64’s, a double, with FVH6 settling at 119-17.75. Given the volatility in stocks, and continued carnage in the energy sector, there is likely more upside in FVH; my original target was 119-24. As the market continues to move higher, consider selling FVH 120.25/120.75 call spread against the lower call spread, at 10/64’s (would likely trade that level at 119-24). That would bring the total cost or risk of the position down to 9/64’s. Max profit of 55/64 would occur at expiry between 119-24 and 120-08.
In terms of recent market action, note that one-year Eurodollar calendar spreads have collapsed. Last week EDM16/EDM17 spread (June 2016 to June 2017) was 60 bps. On Tuesday it settled at a new low of just 42 bps. This is the peak one year spread, and suggests market expectations have been scaled back to only two 25 bp hikes over the course of 2016.
Jeffrey Lacker, the Richmond Fed President, suggested on Tuesday that four hikes would be appropriate in 2016. However, given that crude oil made a new low Tuesday, with Feb Crude probing below $30 bbl interday, it’s hard to see where the inflation pressure are going to come from. The Bloomberg Commodity Index also made a new low Tuesday, and is testing the low from 1999!!!! The index is down 69% from the oil driven high of 238.50 in 2008.