When one talks about interest rate futures, it seems like as if there was only one interest rate future everyone is referring to. However if you look into this interest rate futures can mean anything for anyone. For example the interest rate terms are as short as 30 days all the way up to 30 years. In between these terms there are 5 year, and 10 year Interest rate futures as well.
Each one of these futures products are derivatives of securities which are all within the US Treasury Bonds and notes, basically the debt markets. They are issued by the US Treasury with different terms and rates, and generally there are yields in between the products. The Futures Trading markets are influenced primarily by the U.S. Federal Reserve rate decisions and Bond Traders.
Short Term – Long Term
In order to understand the difference in between these terms to really get a good understanding of the relationship of these instruments.
Interest yields or rates on shorter term treasuries are lower, while interest yields and rates on longer term bonds are higher. Because longer risk for holding for a longer period of time. Federal Reserve controls short term yields, while Bond Traders normally control the longer term bonds markets. Normal circumstances these two products move parabolic to one another.
The image below was borrowed from source, “illusionofprosperity.blog”
The Feds control the lowest available short term rate known as the Prime Rate, and this is why they control the overall economy. Banks are required to hold with the Federal Reserve.
Longer term 30 year Bond Traders influence the market by the buying and selling of these longer term products that have great expectation of bringing in higher rate of returns. Yields run inversely to price of the bonds. Keep this in mind if you are looking to trade the yield curves.
When a country is in good standing the interest charged on long term bonds is less, but when there is turmoil, investors sell the long term bonds, thus pushing the yield higher, which in turn increases the borrowing costs for the nation.
A good example of this is the recent U.S. elections and the campaign promises by President Trump. During the campaign trail, Trump promised fiscal stimulus plans to the tune of a trillion dollars. This meant that the U.S. government, under the Trump administration would be taking on more debt to finance its fiscal stimulus plans. With the U.S. debt already near record highs, investors started to sell the long term bonds, thus pushing the yields higher as a result.
So what happens when the rate get hiked up?
So far, we know that bond traders demand higher yield on long term maturities. Therefore, when the Fed hikes rates (on the short end of the scale), interest rates on the longer dated maturities start to adjust accordingly.
But there’s a catch. Just because the Fed hiked the short term rates doesn’t mean that you will see the 30-year bond yields rise as well. On the contrary, the longer end of the bond yields may or may not rise, which as mentioned earlier in this article depends on the market forces and the perception of the economy among a host of other factors.
Many believe that just because the Fed hikes rates, yields across the spectrum start to rise. But that is incorrect. The yields on the longer dated maturities increase, based on bond trader’s perception of the economy and has nothing to do with the central bank. The Fed can only control so much when it comes to influencing the borrowing costs of the economy, but the large portion of this is left to the open markets.
How do Interest Rate Futures get impacted by a Fed Rate Hike?
Short term Interest Notes on Futures have a very dramatic affect vs. the longer term futures binds have very little to no affect, as investors are looking into 30 years of different geopolitical and inflation circumstances, so typically you will not see the larger bonds having affect to this type of news.
Mid term Treasury noes like the ZN, the Ten Year, can be sometimes be used as a gauge between all other bonds as this instrument sits in the middle of the other shorter and longer terms. Liquidity is large in this 10 year ZN making it a Titanic of an instrument to master and trade.
The ZN is considered a safe haven of investments especially when you see a lot of geo political uncertainty, and risk. This tends to make the price of the ZN rise in these circumstances. (see main photo of this post)
Now you should have a better idea on how to gauge what and how these markets can move in relation to Fed announcements.
Futures trading contains substantial risk and is not for every investor. An investor could potentially lose all or more than the initial investment. Risk capital is money that can be lost without jeopardizing one’s financial security or life style. Only risk capital should be used for trading and only those with sufficient risk capital should consider trading. Past performance is not necessarily indicative of future results.
HYPOTHETICAL PERFORMANCE DISCLAIMER:
HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES LIKE THOSE SHOWN; IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY PARTICULAR TRADING PROGRAM. ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT. IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK OF ACTUAL TRADING. FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS. THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS IN GENERAL OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADING PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF HYPOTHETICAL PERFORMANCE RESULTS AND ALL WHICH CAN ADVERSELY AFFECT TRADING RESULTS.