An Inversion That Will Likely End the Inflation Narrative
(Al Drago/Pool via AP)
An Inversion That Will Likely End the Inflation Narrative
(Al Drago/Pool via AP)
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It’s good that we don’t take these things literally, otherwise we’d have to believe in something like time travel. Not just believe in it, how someone must’ve mastered it a few years ago. Because, looking back, the most straight-forward interpretation of the eurodollar futures market in June of 2018 was that those trading in it had discovered COVID-19 a year and a half before anyone else would. Way before the strain of coronavirus itself had even mutated into the global pathogen it would eventually be.

Plainly recounting the financial details of that hot June (not for temperatures) almost three and a half years ago does make it seem like the market had been just this prescient. Spot on, actually. The Federal Reserve’s policymaking conference, the FOMC, had finished up its scheduled two-day gathering on the 13th, and when it was over the eurodollar futures contract expiring in the month of December 2020 priced below the next three quarterly contracts in line; those of March, June, and September 2021.

It was just a single basis point at first, but what a singularly momentous bip it would turn out to have been.  You see, money like yield curves are supposed to be upward sloping. That’s beauty, economic and financial health being traded about an optimistic future where expectations for things like money and yields are higher just beyond now and then over the horizon.

This is, or should be, even more the case for times like our own, the post-2008 environment when rates in money like yields have been suppressed (not by the Fed, by what’s behind the interest rate fallacy) and ground down to practically, historically nothing. The road back to normalcy is paved in the ascending slope of eurodollar futures contracts extending skyward all the way from front to back.

That is, the prices of these contracts would be declining one right after another. Since the price of each is benchmarked to a 3-month LIBOR index, falling prices is equivalent to expectations for higher yields moving down the curve, further out into that future. From those anticipated higher rates, the market’s curve and its magnificent upward slope.

When on June 13, 2018, the contract price for the March 2021 maturity finished up that day one basis point higher than the contract price for the December 2020 maturity, this was an ugly distortion, an outright violation of that innate loveliness.

Worse, after trading finished up the next day, June 14, the defilement had grown as well as spread around more of the contracts. Now the June 2020 contract priced 1.5 bps below the contract expiring September 2021! In fact, this inversion of natural order went so far as the March 2022 contract.

Taking these prices and conventions literally, the market seemed to be indicating that by the middle of 2020 there would be such a problem the probability of 3-month LIBOR being higher that September than the same June was now substantially less. Not just less probability of continuing higher rates, an actually higher possibility of rates turning in the other direction downward and then extending lower into the following couple years.

In other words, the eurodollar futures market seemed to be saying that by the second half of 2020, chances were increasingly and realistically likely the global situation would be going terribly wrong and stay wrong for a long time.

A higher rather than further lower contract price implies just this sort of probability distribution – that one relative to the other is expecting 3-month LIBOR to more likely be lower than higher. We never, ever associate positive money, financial, and economic outcomes with falling rates, especially if they have anything to do with unexpected and/or involuntary rate cuts.

This is a huge part about why inversion was so astounding back in June 2018. By every mainstream account parroting the official position, there had been absolutely no reason whatsoever to figure any such possibility. Impossible, they said. Hawkish Jay Powell’s hawkish FOMC filled up on globally synchronized growth and the US unemployment rate foretold only of rate hikes far into the future, and then at an accelerating pace.

In truth, the eurodollar futures market – like the Treasury market and a rising US$ exchange value – had already been pricing and expressing substantial skepticism long before mid-year 2018. Each of the two main curves, eurodollar and Treasury, had flattened out in very obvious fashion; its own unlovely distortion to what should be the gorgeous upward sloping.

But flat is not inverted; inverted is next level.

Inverted means, again, the market expecting rates to end up lower than they were just before. It was entirely contradictory to the idea that rates were going up – would or could only go up – for the foreseeable future. A break in a trend which wasn’t supposed to have been breakable.

And if we take these contracts as plain, that juncture when rate hikes would become rate cuts was scheduled for around June 2020 or thereabouts.

That’s the literal interpretation; how trouble was seemingly scheduled to show up in the neighborhood of the middle of 2020 upending Jay Powell’s certainty about rate hikes turning them around into Jay Powell’s reluctant rate cuts.

This is what actually did happen, if within a range of three months of that original inversion “prediction.” The massive downturn, which did include rate cuts all the way down to zero taking 3-month LIBOR with them, was caused by governments overreacting to a novel pandemic which leads us to wonder if the market years before had determined there would be a pandemic to which governments would likely overreact creating the monetary air pocket leading toward drastically lower 3-month LIBOR and other rates.

So, in the middle of 2018, did eurodollar futures really predict COVID almost two years ahead of time?  


I wish it was the case, as that would make things even easier than they are anyway. These markets don’t deal in that level of precision, but even so this stuff is, actually, very easy and straightforward once you learn to speak the language (don’t take the contracts literally) after you have ditched the mainstream Economics behind the Federal Reserve and the cult it has cultivated around itself.

Eurodollar futures, like any other parts of the global “bond market”, trade in probabilities. As I already wrote, before June 2018 the expressed, priced probability distribution in those flattening Treasury and eurodollar curves were shifting downward anyway; that though Jay Powell may have become more confident in higher rates, inflation, and growth, the market more and more doubtful as to each (eurodollar futures specifically 3-month LIBOR, therefore very much an alternate bet as to Jay Powell’s Fed).

The inversion on the 13th was simply the perceived market probability distribution tipping decidedly over into the negative; meaning, the inversion expressed a slightly higher possibility of rate cuts at some unknown point than there would be of continued rate hikes as “everyone” right then said.

The fact this inversion showed up in the December 2020 then June 2020 contracts was mere technicalities coincidentally aligning with the eventual aftermath of the unknowable COVID outbreak.

Eurodollar futures are, at root, a hedging tool for the mammoth fixed income monsters taking on massive balance sheet positions globally. As a consequence, eurodollar futures are used to hedge against the main short run risks – including, or even mostly, the Federal Reserve’s monetary policy targets for federal funds using, nowadays, instruments like IOER and the RRP (reverse repo program) rate.

This means the very front part of the eurodollar futures curve, the first two years of maturities, are heavily influenced by what the FOMC claims it will be doing during the short run. If the FOMC says rate hikes, then these eight quarterly contracts, denoted by colors white (for the first four quarterly) and red (the second group, or pack, of four), will price largely on what the FOMC says.

Therefore, the front part of the eurodollar curve being steep during most of 2018; including the immediate months following the inversion further down it.

Primarily, the market knows how it often and repeatedly takes substantial time for the FOMC to figure out what’s actually going on in the world even as it regularly differs in reality from official projections and forecasts. Something could go wrong today, but the FOMC would be expected to continue to hike rates, for example, into the short-run future (maybe even two years, thus whites and reds) before policymakers figure it out and reverse course.

Beyond the reds are the greens and blues, and it is here where the market is influenced by factors outside this white/red window; the contracts of those colors based on anticipated reality regardless of the Fed’s current position, bias, and stated intentions.

That’s why, in the case of June 2018, the inversion scored its upside-down kink where it did on the curve – just into the greens penetrating outward into the blues. The market wasn’t actually predicting “something” would happen specifically around the middle of 2020, this was simply the technical quirk of eurodollar futures where the greens and blues are “free” from the Fed’s penchant for taking so much to time to realize their own forecasting errors.

The correct way to interpret that inversion was the market pricing a rising and higher probability of rate cuts than rate hikes at some point.  

Eurodollar futures traders didn’t know what it would be, or really when this would happen, rather that initial inversion specified nothing so specific beyond rising deflationary risks of some sort of monetary breakdown creating substantial enough havoc it would lead to a total Fed one-eighty – as it did!

There had been plenty of reasons to suspect as much; again, the first half of 2018 was actually filled with contrary deflationary warnings, one after another. A big one had been Treasuries (and other sovereigns) on May 29, 2018, complete breakdown in collateral that, though unreported by a clueless financial media, was a huge deal in the real economy and this money marketplace for it.

In fact, this was, in all probability, the reason why the previously flat curve warning became full (if tiny at first) inversion on the day it did – June 13, the FOMC meeting. Market participants had been aware of, and increasingly wary of (therefore, flattening), a global monetary system more clearly breaking down.

Yet, as has been the repeated pattern, the FOMC took no notice of these very real, increasingly disruptive monetary troubles, and in fact doubled down on inflation with the comical, absurd rollout of a “symmetrical” inflation target.

The following day, the June 2020’s in eurodollar futures were upside down.

But that’s the thing; this part of the curve wouldn’t remain the only contracts upturned and the inversion didn’t stay tiny for very long. As the year went on, through the summer of 2018 and into autumn, the inversion spread and deepened – and continued to be ignored outside of where it actually counts deep in the bowels of the world’s reserve currency apparatus populated, operated by those same fixed income mammoths.

This spreading inversion in the curve meant two things, neither good. First, it didn’t matter Jay was still hiking rates; the more upside down the curve grew, this said the market was increasingly confident, more so than it already had been to distort the curve into inversion in the first place, the inevitable fallout would be severe enough he’d have to turn it all around.

Second, the spreading inversion meant the market wasn’t just trading on some nebulous fears of way-down-the-road deflationary money breakdown, that very thing was more and more coming into contemporary view. No longer out into the greens and blues, it began to taint and turn the reds, too. Eventually, even the whites.

In other words, the curve in mid-June 2018 was worried and hedging a very non-specific though realistic threat of something going wrong at some point. By around October 2018, the curve’s further transformation indicated a better idea of the threat as well as its timing. By January 2019, full-blown inversion near front to back, more thorough identification and outright indicated immediacy.

Just as it would turn out; recall Powell’s rate hikes unceremoniously ended with a final one in December 2018 and then the embarrassing “Fed pause” early January 2019. The rate cuts, not hikes, would indeed follow by the end of that July; pre-COVID after all.

The eurodollar futures curve had been right all along, if not initially so precise. Realizing, however, we can’t take it literally, it didn’t actually matter. What it had told us back in the middle of 2018 – as inflation hysteria raged all around – was more than enough to begin reassessing everything; that inflation (and growth) expectations were, indeed, near certainly to turn out wrong.

On Wednesday, December 1, 2021, the eurodollar futures curve inverted again. And it turned itself upside down the same way it had back in 2018; first, flattening for months and noticeably flat for weeks going back to late October. And then, this week, now ugly and unnatural by the same colors, from late greens and into the blues.

Taken literally, that might seem to suggest problems manifesting sometime in 2025; who cares, right? But we know that’s not what inversion means. Like before, the market has judged the probability of trouble – not specific at this point – in the uncertain future to be greater than not; the chances of something not as-yet specified going wrong rather than everything going right, it’s now being thought and priced to be a better bet.

We don’t know what, exactly, this trouble is (I can guess, and have all this year) or when it can or will strike, right now we just know it is an entirely too-real risk sitting and waiting for us just over the observable calendar horizon outside the technical whites and reds of eurodollar futures.

As time goes on, should the inversion spread and deepen like it had in 2018 (as well as from December 2006 into 2007), then we’ll know the market sees this “something” as having taken more visible, calculable proportions in time and substance.

Also like 2018, you won’t hear about any of this on the news or outside of a very few places on the internet (like this one!) Insofar as the mainstream is concerned, it is inflation, inflation, inflation for as far as its tainted eye can see. Even Jay Powell has come around to this conventional view, also this week, dropping “transitory” from the FOMC’s language.

Just in time for inversion. A near carbon copy of 2018, he really has impeccable timing.

While the eurodollar futures market hadn’t actually predicted COVID, sorry to say, it did masterfully foretell of Jay’s impending humiliation and more importantly what that would be for the public to suffer his incompetence. Unfortunately for the world, whenever the Fed gets disgraced by money and finance, this means nothing good for those of us living in it.

This rekindled inversion already does indicate a very likely end to the “inflation” narrative of 2021, a welcome development in the narrow sense of consumer prices, yet this would also mean 2022 almost certainly ends up closer to 2019; as a best case.

The curve(s), before time, will tell. 

Jeffrey Snider is the Head of Global Research at Alhambra Partners. 

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