Eurodollar

Eurodollar (pronounced yoor-oh-dol-er)

A US dollar deposited in or credited to an offshore (originally a European) bank.

1958: A compound word, Euro + dollar.  Euro is a contraction of Europe, from the Ancient Greek Εὐρώπη (Eurṓpē); no relationship to the latter-day (eurozone) currency.  Dollar is attested since about 1500, from the early Dutch daler or daalder, from German Taler & Thaler, from the Sankt Joachimsthaler (literally “of Joachimstal”) the name for coins minted in German Sankt Joachimsthal (St. Joachim's Valley, now Jáchymov in the Czech Republic).  Ultimate source is Joachim + tal (valley); cognate with the Danish daler.  Initially, in 1957, known as “Eurbank dollars” and so named after the telex address of one of the first banks involved in the sanction-busting transactions.

Eurodollars

Eurodollars are US dollars on deposit at banks outside the United States.  They’re thus a part of the US money supply not under the jurisdiction of the Federal Reserve (the Fed, the US central bank) and, because of the special role of the US dollar as the world’s reserve currency, are interesting in that they’re subject to oversight by a number of central banks which are national and not international institutions.  The term was originally coined for US dollars in European banks but soon came to refer to all offshore deposits.  Eurodollar is entirely a technical term of the money markets and has no connection with the latter-day currency of the Eurozone although, in the general population, there was some early confusion in the early days of the physical Euro, some mistakenly describing the new paper as Eurodollars.  Within the specialized world of the currency traders, the euro-prefix is sometimes used to refer to any currency held offshore so there’s also the Euroyen, the Europound and even the Euroeuro which, in a charming linguistic paradox, can exist anywhere except within the Eurozone.

In the years immediately following World War II, there was a worldwide shortage of US dollars, the quantity of which outside the US began significantly to increase only as Marshall Plan money began to recapitalize European economies and imports rose in the US, soon to become the largest consumer market of the post-war years.  Another important factor driving the deposits of US dollars into European banks were the pre-emptive moves by the major communist powers, the USSR and the PRC (communist China) to shift their assets from US banks to avoid Washington’s sanctions.  Peaking acted in 1949 at the start of the Korean War; Moscow in 1956 after their invasion of Hungary.

Eurodollars grew in volume also as offshore banks began to offer higher yields on deposits than were available from US institutions; by the early 1970s some US$400 billion (when a billion dollars really was a lot of money) was booked offshore in both short and long-term deposits.  It’s now measured in multiples of trillions (at least for now, a trillion dollars is still a lot of money) but the most important development in the Eurodollar world came in 1981 with the introduction of Eurodollar futures contracts.  Eurodollar futures are an interest rate product, unlike currency futures where contracts are built around actual buying and selling of the commodity.  They’re thus a derivative instrument where players bet on interest rate movements.  Beginning in 1981, during the early days of the Reagan/Thatcher de-regulation project, they were the first of the products which took advantage of the rules of casinos being applied to capital markets.  None of the market crashes since 1987 would have been possible without derivatives.

Eurodollar futures traders who use the market to track short-term US interest rate expectations have for some time been pricing in a rate hike by the Fed by Q3 2022, quite an acceleration on what their earlier charts suggested but increasing uncertainty about the Fed’s reaction to US inflation numbers has seen some traders expect a tightening even earlier.  Some traders have had their Eurodollar fingers burnt before, watching the Fed maintain their existing position and sticking to their long-standing mantra that the US economy needs to achieve certain employment and inflation marks before interest rates will move but the view is now hardening that inflation numbers will force the issue.

The Fed’s position seems to belong to the pre-Omicron world which feels now such a distant memory.  The futures are a bet on the direction of the short-term London interbank offered rate (LIBOR), one of the most widely used interest rate benchmarks in global financial markets.  Investors hedge interest rate risk in the Eurodollar market and in early December 2020, the September 2023 Eurodollar futures contract showed an implied yield of 0.50%, suggesting traders were expecting the Fed to deliver a 25 basis-point hike by then.  Since then the world has changed.

Changed so much that predictions for the inflation outcome seem enough for the Fed to reconsider the “Greenspan put” (named after Dr Alan Greenspan (born 1926; Chair of the US Federal Reserve 1987-2006) and the actions he took in ensuring sufficient liquidity remained in the US system for business to continue as close to "normal" as possible; now often called the "Fed put"), in place (off and on) for over thirty years, despite recent declines in US stocks and other risk assets, the tech-heavy Nasdaq having fallen over 10%.  That’s how much the specter of inflation can spook central bankers and the Eurodollar futures suggest the traders have priced-in a quarter-point rate rise for March and perhaps a full percentage point by the end of calendar year 2022.  Despite that, traders still are not writing an obituary for the Greenspan put, noting it has been debatably the most influential tool in the Fed’s century-long history and, as an essentially reactive institution, it’s revival to deal with even a few local difficulties will not be unexpected.