Daily Clueless Musings 6/8

Eurodollar futures continue to rally, after Bernanke's dovish speech yesterday. Slowing economic activity and weak labor market are not news. Bernanke also "explained" to the market that Fed's zero rate policy is not causing rising commodity and weakening dollar (thus, maybe, he implies that raising rates is not going to be the right response to solve those issues, when they come.). He seems to be concerned about the potential fiscal drag from both state and federal level, as he spent two paragraph discussing how the fiscal drag will slow down the recovery. We should expect more "stimulus" from Fed, if there is larger than expected cut on government spending. Mr. Bernanke also suggested that, rather than buy more assets, the Fed is more likely to respond to the slowdown by holding on to the assets that it has for a longer period. Holing the bloated balance sheet at Fed steady and keeping interest rate at zero (or negative real interest rate) for extended period is likely going to the unofficial QE3. Ironically, although Bernanke again denied more quantitative easing/ asset purchasing program, the number of key word "QE3" hits on Google search made new high after his speech. Eurodollar futures have no way to go but up, although they have already priced in very low probability of rate hiking before mid 2012. Volatility is low, as Fed once again assures the market Fed tightening monetary policy is further than more options will expire. Longs rushed to accumulate more futures before the 10 year auction, which unsurprisingly turned out to be strong. Yield on 2 year closed at 38 basis points, only 4 basis points higher than the all time low. Speculators are blamed for higher oil prices. Do we really think the real money investors are chasing 38bps yield for 2 years, when core CPI prints 102 bps higher? paper continue to acquire long delta exposure by selling vols. They sold green H 80 put to buy 81-2 call spread 8 times.