Eurodollar Futures Explained

Futures contracts

The Eurodollar futures contract refers to the financial futures contract based upon these deposits, traded at the Chicago Mercantile Exchange (CME). Eurodollar futures are a way for companies and banks to lock in an interest rate today, for money it intends to borrow or lend in the future.^[7] Each CME Eurodollar futures contract has a notional or "face value" of $1,000,000, though the leverage used in futures allows one contract to be traded with a margin of about one thousand dollars.^[8]
The minimum fluctuation in a Eurodollar contract is one-quarter of one basis point (0.0025% = $6.25 per contract) in the nearest expiring contract month, and one-half of one basis point (0.005% = $12.50 per contract) in all other contract months. ^[9] Trading in Eurodollar futures is extensive, and the market for them tends to be very liquid.
CME Eurodollar futures prices are determined by the market’s forecast of the 3-month USD LIBOR interest rate expected to prevail on the settlement date. The settlement price of a contract is defined to be 100.00 minus the official British Bankers Association fixing of 3-month LIBOR on the contract settlement date. For example, if 3-month LIBOR sets at 5.00% on the contract settlement date, the contract settles at a price of 95.00.^[10]

How the Eurodollar futures contract works

For example, if on a particular day an investor buys a single three month contract at 95.00 (implied settlement LIBOR of 5.00%):

• if at the close of business on that day, the contract price has risen to 95.01 (implying a LIBOR decrease to 4.99%), US$25 will be paid into the investor's margin account; or
• if at the close of business on that day, the contract price has fallen to 94.99 (implying a LIBOR increase to 5.01%), US$25 will be deducted from the investor's margin account.

On the settlement date, the settlement price is determined by the actual LIBOR fixing for that day rather than a market-determined contract price.

Eurodollar futures contract as synthetic loan

A single Eurodollar future is similar to a forward rate agreement to borrow or lend US$1,000,000 for three months starting on the contract settlement date. Buying the contract is equivalent to lending money, and selling the contract short is equivalent to borrowing money.
Consider an investor who agreed to lend US$1,000,000 on a particular date for three months at 5.00% per annum (months are calculated on a 30/360 basis). Interest received in 3 months' time would be US$1,000,000 × 5.00% × 90 / 360 = US$12,500.

• If the following day, the investor is able to lend money from the same start date at 5.01%, s/he would be able to earn US$1,000,000 × 5.01% × 90 / 360 = US$12,525 of interest. Since the investor only is earning US$12,500 of interest, s/he has lost US$25 as a result of interest rate moves.
• On the other hand, if the following day, the investor is able to lend money from the same start date only at 4.99%, s/he would be able to earn only US$1,000,000 × 4.99% × 90 / 360 = US$12,475 of interest. Since the investor is in fact earning US$12,500 of interest, s/he has gained US$25 as a result of interest rate moves.

This demonstrates the similarity. However, the contract is also different from a loan in several important respects:

• In an actual loan, the US$25 per basis point is earned or lost at the end of the three-month loan, not up front. That means that the profit or loss per 0.01% change in interest rate as of the start date of the loan (i.e., its present value) is less than US$25. Moreover, the present value change per 0.01% change in interest rate is higher in low interest rate environments and lower in high interest rate environments. This is to say that an actual loan has convexity. A Eurodollar future pays US$25 per 0.01% change in interest rate no matter what the interest rate environment, which means it does not have convexity. This is one reason that Eurodollar futures are not a perfect proxy for expected interest rates. This difference can be adjusted for by reference to the implied volatility of options on Eurodollar futures.
• In an actual loan, the lender takes credit risk to a borrower. In Eurodollar futures, the principal of the loan is never disbursed, so the credit risk is only on the margin account balance. Moreover, even that risk is the risk of the clearinghouse, which is considerably lower than even unsecured single-A credit risk.

Other features of Eurodollar futures

40 quarterly expirations and 4 serial expirations are listed in the Eurodollar contract.^[11] This means that on January 1, 2011, the exchange will list 40 quarterly expirations (March, June, September, December for 2011 through 2020), the exchange will also list another four serial (monthly) expirations (January, February, April, May 2011). This extends tradeable contracts over ten years, which provides an excellent picture of the shape of the yield curve. The front month contracts are among the most liquid futures contracts in the world, with liquidity decreasing for the further out contracts. Total open interest for all contracts is typically over 10 million.
The CME Eurodollar futures contract is used to hedge interest rate swaps. There is an arbitrage relationship between the interest rate swap market, the Forward Rate Agreement market and the Eurodollar contract. CME Eurodollar futures can be traded by implementing a spread strategy among multiple contracts to take advantage of movements in the forward curve for future pricing of interest rates.

Sweeps

In United States Banking, Eurodollars are a popular option for what are known as "sweeps". By law,^[12] banks aren't allowed to pay interest on corporate checking accounts. To accommodate larger businesses, banks may automatically transfer, or sweep, funds from a corporation's checking account into an overnight investment option to effectively earn interest on those funds. Banks usually allow these funds to be swept either into money market mutual funds, or alternately they may be used for bank funding by transferring to an offshore branch of a bank.

As Markets Become Unravelled

from m3 Financial Analysis blog:

The markets are dissolving…they are TOTALLY disconnecting due to the stresses caused by deleveraging…IT IS NOT PRETTY and it is totally the result of central economic planning…what a mess. A major disconnection around these corners awaits.

For more information regarding what the EURODOLLAR contract is: click here

Posted by pc at 1:46 PM

Eurodollar Futures Plunge on Europe's Debt Debacle

This is coming to the United States treasury markets sometime, possibly soon!

Eurodollar Futures Rocket Higher on ECB Rate Hike Likelihood

HONG KONG, April 4 (Reuters) - Eurodollar futures contracts expiring in March 2012 are forecasting a half point increase in U.S. interest rates, helped by increasing evidence that the economy is gaining momentum.
A widely expected rate increase by the European Central Bank on Thursday could also add pressure on the Federal Reserve to begin reversing its super-loose monetary policy.
Such an increase would be the ECB's first rate hike since October 2008 and widen interest rate differentials further between the U.S and Europe.
A surge in eurodollar futures in early March fuelled by expectations that the earthquake in Japan would stay the Fed's hand in tightening policy has taken a sharp U-turn in the past two weeks due to hawkish comments from some Fed officials.
While the disaster could push the Japanese economy back into recession for a few quarters, analysts now do not expect it to have a major impact on global economic growth.
Barclays strategists said the March employment report, which showed the U.S. jobless rate slipping to 8.8 percent, signaled a continuation of the trend towards solid business expansion, notwithstanding risks such as the Middle East unrest and rising commodity prices.
Even though the shift in rate expectations has led to some heavy profit-taking in the eurodollar and fed fund futures markets, a majority of analysts in a Reuters poll do not expect a rate hike in 2011. 
"The message here is that we do not believe the softness in the first quarter data should be interpreted as the start of a significant slowdown," they said.
Underlining that optimistic view, hawkish comments from some Fed officials hurt the market last week with two-year Treasuries , seen as among the most vulnerable to interest rate risk, underperforming longer-dated debt including 10-year notes.
Two-year notes briefly tested support at yields of around 0.89 percent on Friday, their highest levels since last May before subsiding to around 0.80 percent on Monday.
The gap between two-year and 10-year note yields has narrrowed to around 266 basis points from 283 bps on March 8.
Players in the fed fund futures markets are expecting about 40 bps of increase in U.S rates by March 2012.
Rate markets are also eyeing a speech by Fed chief Ben Bernanke later in the day where he might temper some of the recent hawkish comments by other Fed officials. (Editing by Kim Coghill)

Eurodollar Rises Steadily for 3 Months, Tanks on Ireland Debt Downgrade

European debt is back in the headlines. After S&P downgraded Ireland's debt last night, also issuing a warning that further downgrades may lie ahead, fresh worries about other European countries' debt resurfaced, causing the Eurodollar futures to tank.

Sickly Spain: Debt Downgrade Debacle

On news that Fitch's has downgraded Spain's debt rating, LIBOR has reversed and begun rising again. Eurodollar futures have accordingly reversed to the downside.Debt worries are back!

Libor Drop Paints Incomplete Picture

excerpt from FT.com:

However, analysts and bankers warn that Libor rates may not be telling the full story.

That is because there are wide differences between the rates at which individual banks can borrow. The biggest institutions are able to fund themselves at around Libor levels while smaller institutions have to pay, in some cases, more than 100 basis points above Libor. This is explained by continuing counterparty risk in what remains an uncertain economic environment.

That contrasts with the situation before the credit crisis when institutions paid similar rates to borrow.

Meyrick Chapman, fixed income strategist at UBS, says: “We should not build up our hopes that the fall in Libor is such a positive sign for the markets. We have a very tiered market, where many smaller banks are still having to pay relatively high rates to borrow.”

Lena Komileva, head of market economics at Tullett Prebon, adds: “What we are seeing is a huge difference in the price of borrowing for individual banks. There is a higher proportion of banks paying above Libor.”

The British Bankers’ Association, which sets Libor by compiling an average cost of lending from the 16 banks, defends the rate, stressing that the market understands it is a reference point for the strongest banks.

John Ewan, director at the BBA, says: “We use 16 banks to set the Libor rate. They are among the biggest banks in Europe. The market knows this and understands that other smaller banks may have to pay more. This is not a false signal to the markets.”

Some analysts also point out that a rate of 100bp above Libor is still very low on an historical basis. Libor rates are at record lows as they track central bank rates, which are close to zero in the US, 0.5 per cent in the UK and 1 per cent in the eurozone.

Central banks have helped the market, too, by providing vast amounts of liquidity in secured lending, where banks and institutions can raise money at low rates in exchange for collateral.

However, the higher rates the smaller institutions have to pay in the unsecured lending markets, which were the most flexible and easiest to access before the credit crisis, will slow recovery as the higher costs will act as a drag on their earnings and mean institutions will take longer to recapitalise. Institutions also face difficulties funding much further out than three months as banks are reluctant to lend beyond this period due to counterparty risks. And when they do so, it is at punitive rates.

At the same time, funding in the longer-term corporate bond markets is very expensive.

The bond markets, where bond funds and asset managers are the main lenders rather than the banks, may be open with issuance at record levels, but the costs for an investment grade company is nearly 200 basis points more than it was at the start of 2008.

The average rate for a triple-B rated company to issue bonds in dollars is 7.75 per cent compared with 5.92 per cent in January 2008, according to Merrill Lynch.

That forces many institutions to roll over their debt in the short-term markets, where maturities are typically no more than a month.

Significantly, this type of funding is likely to become more expensive as most analysts expect Libor rates to rise with official central bank rates unlikely to fall much lower.

Steven Major, head of global fixed income at HSBC, says: “Libor is very misleading. The published levels may be very low compared with recent history, but in reality I am not convinced much volume is going through beyond the one-month maturity. Furthermore, if institutions want to fix their debt over a longer term they have to pay enormous rates to do so.”

Gary Jenkins, head of fixed income research at Evolution, agrees: “The fall in Libor rates is not a great guide to what is happening in the overall economy. We are definitely in for a long haul. We won’t get back to a situation where banks are lending in the way they were before the credit crisis for a long, long time.”

LIBOR Falls to Record for Recession

As LIBOR falls, the Eurodollar futures rise (see chart).

from Bloomberg:
The cost of borrowing in dollars between banks had its biggest two-day drop in more than four months amid confidence record low interest rates and a recovery among financial institutions is unlocking credit.

The London interbank offered rate, or Libor, for three- month dollar loans declined three basis points today to 0.75 percent, the British Bankers’ Association said, bringing its drop in the past two days to seven basis points, the most since Jan. 13. The rate has decreased in each of the past 35 days.

“The tension has disappeared and we are gradually normalizing,” said Patrick Jacq, a senior fixed-income strategist in Paris at BNP Paribas SA, the biggest French lender. “There’s less stress in the market and banks know they will get liquidity.”

Eurodollar Futures: Now That's Some Trend

Every day I expect this trend to reverse, or consolidate, especially since it is based upon interest rates for Libor. However, it just keeps going and going.

From Moneycafe.com:

LIBOR stands for "London Inter-Bank Offered Rate." It is based on rates that contributor banks in London offer each other for inter-bank deposits. From a bank's perspective, deposits are simply funds that are loaned to them. So in effect, a LIBOR is a rate at which a fellow London bank can borrow money from other banks. Rate calculations are complex as they incorporate variables such as time, maturity and currency rates. There are hundreds of LIBOR rates reported each month in numerous currencies.

Apparently, since LIBOR is a rate that banks charge to lend to each other, it is reflective of confidence in the financial markets. The Eurodollar is a futures derivative that mimics LIBOR. It continues to fall as long as confidence between banks is improving. It is also extremely liquid, with more than 1,000,000 of open interest.

I have begun to wonder, with the Eurodollar approaching a value of 100, if that price is equivalent to a zero percent interest rate for LIBOR. From the CME's website:

"Quoted in IMM Three-Month LIBOR index points or 100 minus the rate on an annual basis over a 360 day year (e.g., a rate of 2.5% shall be quoted as 97.50). 1 basis point = .01 = $25."

This suggests that with the Eurodollar priced today at 99.1300, the LIBOR rate would be .8700%, which is obviously less than 1%. Since the low rate is reflective of high confidence, it appears to represent the return of rising confidence in the financial markets, and particularly the lending between banks outside the United States. It closely mirrors both LIBOR and the Fed Funds rate, but is not set by the Fed.

LIBOR Rising, Unobstructed By Government

This chart shows the Eurodollar futures, which are very liquid, with more than 1 million contracts of open interest. It is linked to LIBOR (London Interbank Offered Rate), which is the rate that U.S. Dollar deposits earn on accounts outside the United States. In an era in which the Federal Reserve artificially manipulates interest rates through quantitative easing, LIBOR and the Eurodollar futures are a more accurate barometer of unobstructed interest rates.

This daily chart shows that Eurodollar futures are gradually, but slowly declining in value because of rising interest rates that investors are demanding to assume the rapidly-expanding risk of investing in dollar-denominated debt, and especially U.S. government debt. With the U.S. treasury planning to borrow about $2 trillion this year, investors are showing increasing skittishness at the idea of accepting this risk without hiking the interest they earn in compensation.

Today's candle indicates a possible breakout is imminent, with "unobstructed" interest rates potentially rising much more rapidly. The long wick on today's candle, however, is somewhat worrisome, since it may form a hammer, a reversal signal. I love to trade the Eurodollar futures because they are very liquid, and move fairly slowly. I consider it to be "easy money".

(Interest Rate) Eurodollar Futures Continue to Move Higher

This chart does not depict the Euro Forex futures, but the Eurodollar interest rate futures. Eurodollars are U.S. Dollars deposited in banks outside the United States. Like treasury futures, the price of Eurodollar futures moves inversely to interest rates, so this chart suggests that Eurodollar interest rates continue to drop.

Leaping LIBOR!

LIBOR and Eurodollar deposits have leaped higher today as interest rates continue to drop even lower! The two futures are closely linked, since Eurodollar deposits are settled at the LIBOR rate. Both represent short-term interest rates on foreign deposits of US Dollars. The Eurodollar is much easier to trade, since it is far more liquid and maintains a very tight, 1-tick bid/ask spread almost around the clock!

Here is a story explaining the lower LIBOR rates.

From Bloomberg:

"Libor, the benchmark for $360 trillion of financial products worldwide, is set by a panel of banks in a survey by the BBA before noon each day in London. The euro interbank offered rate, or Euribor, is published by the European Banking Federation earlier in the day."

Here is another one from Bloomberg that offers a very good explanation of various Interbank rates.

There appears to be a fundamental global conflict between bonds and equities right now. Bond prices seem to be predicting near-depression-era economic results, while equities are signaling a bottom for the stock markets. TED spreads typically have been one of the most reliable indicators of recessions throughout several decades, and they remain quite bearish despite improvements in recent days and weeks.

Eurodollars Take Off

I love to trade Eurodollar (this is the interest rate instrument, not the Forex-related one) futures because they are very liquid (OI > 1,000,000 contracts) and provide one of the most reliable signals in futures. However, I must admit that I haven't the slightest idea what moves this futures instrument. It does not correlate at all with treasuries. The CME's website says that the Eurodollar represents US Dollars on deposit in banks outside the United States and that the contract is settled upon delivery at the LIBOR rate. However, it seems to operate with very little correlation to the US Dollar Index, LIBOR (except on the delivery date), or treasury interest rates. It also tends to move much more gradually than most other trading instruments, so I don't have to have a lightening-fast clicking finger to trade it.

Treasuries Thin Also; What's Trading Well

Traders in treasuries must have gone on vacation en masse today also. Volume is so thin that the tick chart is lagging severely behind even the shortest time interval charts.

However, I have had good results today so far trading the Eurodollar futures! They are very liquid, probably because many European trading desks are unaffected by the Thanksgiving Holiday.

Shorting the Euro currency futures has also been a good trade. The US Dollar has shown some solid strength today, after showing considerable weakness over the past few days. I trade what the market tells me to trade.

Eurodollar Futures Also Highly Liquid

This chart for the daily Eurodollar futures is also extremely liquid, often with more than 1.5 million contracts of Open Interest. The margin requirements are fairly low, being roughly comparable to the treasury futures. I know very little about the Eurodollar, but watch its movements nevertheless. It apparently represents the interest rates paid by banks on CD's outside the United States on US Dollar deposits. It tends to mirror the activity of the LIBOR futures, but is much more liquid than LIBOR. I am also hoping that there will eventually be an ETF to trade the Eurodollar (not the Euro or EURUSD Forex) futures. The Eurodollar is an interest rate futures vehicle, not a currency trade. Here is what the CME website says about the Eurodollar:

The Eurodollar futures contract is the most widely traded and versatile interest rate futures product in the world. It provides a valuable, cost-effective tool for hedging interest rate fluctuations on Eurodollars – U.S. dollars deposited in commercial banks outside the United States. Eurodollar deposits play a major role in the international capital market, and have long served as a benchmark interest rate for corporate funding.

Other Futures

Here are the charts for three other futures that I have started following. Note the similarity between their charts, as shown here on the daily charts.

Fed Funds

LIBOR

Eurodollar