Projections by the Federal Reserve that it will start to hike interest rates as early as one year from now have sent interest rate futures volumes climbing, pulling in OTC interest-rate derivatives along with it.
The Federal Open Market Committee said it continues to anticipate that conditions will likely warrant maintaining the current range for the federal funds rate for a “considerable time” after the asset purchase program ends, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.
During her press conference, Fed chairman Janet Yellen said that “considerable time” meant about six months, which would place the rate hike in April 2015, or six months after the expected end of quantitative easing this fall.
“There were two elements, I think, that led market participants to imply an increase in rates to sell off our Eurodollar futures, in particular in the 2015, 2016, 2017 parts of the curve,” said Sean Tully, managing director of the interest rate products team at CME Group. “The Federal Reserve is now publishing the FOMC's own forecasts quarterly for a number of different time series, in particular GDP, inflation, the unemployment rate. But most importantly, they're also publishing forecasts from the FOMC members' on the Fed funds rate. For 2015 in particular, a lot of those forecasts drifted upwards.”
Since the FOMC members have adjusted their expectation, the marketplace has adjusted its expectation. On March 19, the day of Yellen’s press conference, volume in CME’s Eurodollar futures hit more than 6 million contracts, triple the volume of the day before. “You generally see a spike in volume the greater the volatility of the market or the larger the expectations change due to new information,” said Tully. “So we typically see spikes in volatility around significant economic events like a nonfarm payroll number or FOMC dates, and a spike in volume.”
Tully added, We're really excited to see the Eurodollar futures grow and get such great traction and that the marketplace uses them in order to hedge and manage their short-term interest rate risk.”
CME also saw an increase in cleared OTC volumes as well as an increase in futures volumes. “You generally get greater interest rate swap trading on days with higher volatility in rates,” Tully said. “Eurodollar futures and interest rates are closely related instruments. So you would generally expect that if you have a high volume day in Eurodollars that you also have a higher volume day in swaps. “
In the United States, hedge funds, asset managers, banks, insurance companies have been required to clear interest rate swaps since 2013. “Our OTC clearing volumes have increased dramatically over this time,” said Tully. “If you go back to the beginning of last year, we were clearing on the order of ten billion a day. Yesterday we cleared two hundred and sixty three billion. That gives you an order of magnitude. We continue to get better traction with our customers in OTC clearing. It's a matter of us continuing to on-board new customers and getting more volume from existing customers."