I am watching the energy, grain, meat, and currency markets in addition to the Eurodollar, which I consider to be a benchmark for short-term interest rates in the futures markets. In my view, there will be plenty of clues hidden in the reactions of these assets that could be useful as we head toward the second half of the year.
Watching Eurodollar Futures
The Eurodollar interest rate futures contract, among the most liquid in the world, represents the interest rate paid for U.S. dollars deposited in overseas banks. Specifically, it trades like a discount bond in which its value subtracted from 100 basis points reveals the anticipated yield. For example, if the Eurodollar is valued at 98, the implied rate is 2 percent (100 - 98). As short-term interest rates go down, the Eurodollar goes up and vice versa.
The euro currency futures contract and the Eurodollar futures settle in the opposite direction in roughly 83 percent of trading sessions (throughout the previous 180 days). Further, most commodities settle in the same direction as the euro over time, with correlations ranging from 25 percent to 90 percent. Thus, we can infer that whatever action the Fed takes, or doesn't, we will see the aftermath bleed into the commodity markets.
A Chain Reaction in Commodities
A move in the Eurodollar lower and the euro currency higher could create a chain reaction throughout the commodity markets. For instance, a higher euro currency (which is the equivalent to a weaker dollar) would be supportive of commodities such as oil, natural gas, and even grains, softs, and meats.
In summary, if the Federal Reserve fails to confirm rate cuts in the coming months, interest rate products such as the Eurodollar will likely decline, and currencies paired against the U.S. dollar will likely increase. The change in market outlook regarding interest rates would impact the currency market composition and eventually work its way into support for commodities. Regardless of the position the Fed takes going forward in 2019, we can see clearly why market participants in all asset classes watch their decisions closely.
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