Top Advisors Corner

Tom McClellan: Eurodollar COT Model Calls For Continued Rates Drop


Short-term interest rates have been falling, pushing the Federal Reserve to cut its own Fed Funds rate target. This week's chart says that there is still a lot further for rates to fall.

I get a lot of data out of the CFTC's weekly Commitment of Traders (COT) Report, and I review the relevant insights every Friday in my Daily Edition. This week's chart features data from the Eurodollar futures contract, showing the "commercial" traders' net position in that contract. That is the red plot, and it is shifted forward by 10 months in the chart to reveal how those traders' movements tend to show up again in the movements of 3-month T-Bill yields. Those 3-month yields have started the big drop which this indicator has forecasted, and it says that there are still at least 10 more months of falling yields ahead.

This leading indication did not work so well from 2009-2015, when the Federal Reserve was employing a "zero interest rate policy," a.k.a. ZIRP, thinking that the Fed's experts knew better than the bond market what interest rates should be. When the Fed finally let rates start to rise in late 2015, the path of T-Bill yields got itself back into sync with this model. 

What it does not tell us is exactly how far rates should fall. This model is pretty good at getting the direction right (when the Fed does not put a thumb on the scale), but how far the T-Bill yields may go can vary. What I have found, though, is that if you get the direction right, the magnitudes will take care of themselves. 

I used to use this Eurodollar COT data as a 1-year leading indication for the movements of the stock market, and it was a really good one while it lasted. It started to break down when the Fed started QE3. For a while afterward, the model seemed to start working again, but the correlation is horrible lately. 

It is still working, though, for short term interest rates.

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