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Short term interest rates

Short term interest rates (STIR) depend on the market’s short-term expectations for growth and inflation.

The markets which trade on short-term expectations for growth and inflation and the related central banks’ future moves (raising/reducing interest rates, QE/QT) are the following interest rate futures:

  • LIBOR ($, Euro, GBP) futures
  • Interest Rate Swaps
  • Eurodollar futures
  • Fed Fund Futures
  • SOFR Futures
  • SONIA Futures

MacroVar analyzes the dynamics, provides models and holds historical data for the fixed income futures above.

London Interbank Offered Rate (LIBOR) is perhaps the most important rate in global financial markets. The 3-month LIBOR is the dominant gauge. LIBOR is not directly tradable, but drives the Eurodollars futures market.

Secured Overnight Funding Rate (SOFR) is based on US Treasury repo transactions and will replace LIBOR by June 2023.

Sterling Overnight Index Average (SONIA) is based on actual transactions and reflects the average of the interest rates that banks pay to borrow sterling overnight from other financial institutions and other institutional investors. It will replace LIBOR by June 2023.

Eurodollar Futures: Eurodollar deposits are time deposits at banks outside the Fed’s jurisdiction. Eurodollar futures contracts are the most heavily traded futures contracts in the world, driven by the wholesale funding market.

Federal (Fed) Funds: Federal funds, or Fed funds, are unsecured loans of reserve balances that depository institutions make to one another.

Interest rate Swaps: Interest rate swaps are derivatives that allow an investor to exchange one set of interest payments for another. The most common interest rate swaps are fixed-for-floating swaps, where the investor or hedger has the choice to receive a fixed rate and pay a floating rate, or pay a fixed rate and receive a floating rate.

Overnight Indexed Swaps (OIS): An overnight index swap (OIS) is a fixed-for-floating interest swap that is indexed against an overnight rate. They are great tools to hedge or speculate in central bank action and typically have a maturity of less than two years.

Short-Term Interest Rates Logic

When the US economy is strong and inflation expectations rising the market should be expecting central banks to raise rates in order to decelerate economic and inflation expectations. STIR are linked to the macroeconomic environment, fiscal and monetary policies and the financial markets (commodities).

Hence, short term interest rates should be expected to rise and their related futures which are Eurodollar, Fed Funds and 3M LIBOR futures should sell off. At the same time and since markets are interrelated, fixed income markets are linked the Yield Curve (10-year minus 3-month) must be steepening and business surveys must be strong.

When central banks set rates correctly, we should expect smooth slope implied curve in the short term interest rate futures markets.

Highly sloping implied rate curves imply that the central bank reacted too late, the economy has overheated causing inflationary pressures and the futures markets imply aggressive interest rate hikes.

Inverted implied rate curve imply that the central bank reacted too late which has to be more aggressive in order to combat inflation pressures, causing the business cycle to shorten and a possible recession due to early hikes and also the market expects rate cuts later on.

Central bank meetings, especially the FOMC meeting affects these markets to a large extent. When FOMC becomes more hawkish (tendency to raise rates) or dovish by either adjusting interest rates and/or use QE/QT, it affects the STIR futures markets directly.

When the fed funds futures implied rate goes below the US 2-year bond yield it means market expects Fed cuts since economy weak / recession.

MacroVar models monitor the following interest rates:
  • Fed Fund effective, upper target and lower target rates
  • Fed Fund Futures
  • Eurodollar futures
  • Fed Fund Futures
  • SOFR Futures
  • SONIA Futures
  • Overnight Interest Rate Swaps
  • IOER
  • US Treasury Yield Curve
  • US Swaps Curve

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