Tuesday, May 26, 2009

The Debts of the Lenders: Eurodollar Futures and COTs Data Narrate the Extent of the Equity Rally

Data from the latest Commitment of Traders report on May 22 shows an EXTREME imbalance in contracts purchased. That imbalance has grown since the last report a week earlier on May 15.

The frothiness is apparent in Eurodollar futures with front month contracts breaking outside of Fibonacci resistance levels. Eurodollars are mostly traded by institutions seeking to hedge spreads over government interest rates (e.g. the contracts measure the premium banks must pay per 3 month LIBOR and the yield curve's steepness).

But what this activity reveals is a lot more than just trading in one asset class - it represents the cost of credit itself to big players and encourages excessive risk taking. As a result, 2 asset classes have benefited the most from the rally - a) commodities, which are traditionally associated as an inverse inflation hedge; and b) high beta plays, such as commercial real estate, casinos, luxury retailers, and other poor fundamental stocks.

Further examination of the daily chart reveals additional insight. Volume has DRAMATICALLY declined since early May. And the RSI is coming down from an overbought peak.

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