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Fed Funds COT: A Fun Leading Indicator

Chart In Focus
May 08, 2014

I like to get answers ahead of time.  So I like to find data relationships which can do that for me.  This week's chart features a fun one, employing data from the weekly Commitment of Traders (COT) Report. 

The "commercial" category of traders are the big money traders, and they are presumably also the smart money.  Commercial traders of 30-day Federal Funds (FF) futures contracts have been ramping up their net long position as a group in a big way.  History shows that this is a bullish message for the stock market. 

In the chart above, the commercials' net position in FF futures is shifted forward by a month to show how the movements of the SP500 tend to trace out roughly the same footsteps.  So the immediate message for the market is that stock prices should head higher, at least over the next month or so. 

The price pattern of the SP500 does not perfectly replicate what the commercial FF traders were doing a month before.  But it comes pretty close, and the alignment of the important bottoms is really nice.  And this relationship has been going on for several years, since long before I uncovered it. 

This next chart takes a really long look, again with the FF COT data plot shifted forward by a month.  It shows a generally great correlation over the years, but it also shows a couple of really problematic periods for the relationship:

Fed Funds COT data 2006-14

In 2012, right after I uncovered this historically close relationship, the correlation went all kablooie.  That was coincidentally when the Federal Reserve was implementing "Operation Twist", exchanging short term debt for longer term debt, and thoroughly stamping out the messages from the bond market in the process.  When the Federal Reserve started QE3 in September 2012, this relationship started the process of disinverting, and by the start of 2013 the two plots were back in sync once again.  They remain so today. 

The continued up move just recently by the FF COT data says that the stock market should continue higher.  But there is simultaneously a problem wrapped in that message, because the commercials' net position as a percentage of total open interest is now at its highest level ever.  It is even higher than the peak it saw back during August 2007, just ahead of the final price top. 

Fed Chairman Janet Yellen says that she is not going to stop QE for several more months, let alone allow interest rates to rise anytime soon.  But the smart money commercial traders are stocking up on long positions in 30-day FF futures, which for the moment is bullish for the stock market.  How long that lasts is not known, but those who can watch this relationship should at least get about a month's notice of when the turn comes. 

Tom McClellan
Editor, The McClellan Market Report

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