ST Note - Interest rate futures

RBA raised cash rate by yet another 25 bps to 3.6%, highest in nearly 11 years but dovish tweak of comments about next rate hike triggered spike in AU treasury bond futures.  On the other hand, last night Powell’s hawkish comments in the Senate testimony also hinting possibly raising the terminal rate at this month’s FOMC meeting caused the sell off in the shorter end treasury futures – particularly between 2 and 5 years – and also yield curve (2 year and 10 year) inverted to more than 100bps for the first time since 1981 as 2 year yield rose well above 5% handle while the Fed funds futures now implies 100bps hike in the next 3-4 months.

There are number of key events coming up this month, including  Powell’s testimony in the US house (8^th), Kuroda’s final BOJ meeting (10^th), NFP (10^th), US CPI (14^th) and finally crucial FOMC meeting (23^rd) that would also update the economic projections and dot plot, therefore we expect volatilities to remain elevated through out creating trading opportunities using broad ranges of futures contracts.

Majority of the interest rate futures available in the platform are traded in CBOT, EUREX or SFE.  In APAC, US 10 year (ZN), 5 year (ZF) & 2 year (ZT) treasury notes have the highest turnover as well as 3 month bills including Eurodollar (GE) – soon to be replaced by SOFR (SR3).  AU 3 year and 10 year T-bond alongside Mini JGB (SJB) and 10 year Japanese government bond (JGB1) are also popular contracts.

Bond futures are quoted in percent of par (e.g. US treasury futures are priced to the nearest 1/32^nd of 1% of par or even finer increments for shorter maturities) but non coupon bearing money market (maturity less than 12 months) instruments such as SOFR trade in yield terms so SR3 is converted into IMM (international monetary market) convention (e.g. 100 – compounded daily SOFR interest during contract Reference Quarter).  Similarly AU bonds (XT, YT) are quoted as 100 minus yield to maturity, therefore tick value does not remain the same and fluctuates according to the underlying interest rate.

Interest rate futures are mostly traded for hedging short to long term interest rates and cost effective way to improve portfolio returns by speculative trading (long or short) with benefits of liquidity, leverage, price transparency and low counterparty risk.  SR3 and ZQ are effective tools that are widely used for hedging short-term interest rate risk with monthly expiries while also reflects the expectations of Fed’s monetary policy.  Further more the shape of yield curve can also be anticipated by combining the futures contracts with different maturities to form a spread for six different types of scenarios that could pan out – parallel shift (up/down), bull/bear flattener, bull/bear steepener.

Examples of trade ticket & key components of specs

US Treasuries

Secured Overnight Financing Rate & Fed Funds

AU Treasuries

JGB

Margin

https://www.home.saxo/en-sg/rates-and-conditions/futures/initial-and-maintenance-margin

Specifications

https://www.home.saxo/-/media/documents/business-terms-and-policies/futures-contract-specifications.pdf?revision=fc71040a-13cf-4910-bbbf-2a9bab921841

Expiry for physical settlement (e.g. ZN, ZF, ZT)

• If the expiry day is prior to the first notice day (FND) as utilised by Saxo Markets, the contract will be closed on the expiry day.
• If the FND as utilised by Saxo Markets is the same or prior to the expiry day the contract will be closed the trading day prior to such FND.

Yield curve & DV01 - dollar value of 1 basis point change

See under summary – CTD/OTR to match duration or work out hedge ratio

e.g. Long 100 lot ZTH3 and short 52 lot ZNH3 with spread ratio of 0.5169 (DV01 of $34.11 / $65.98)

https://www.cmegroup.com/tools-information/quikstrike/treasury-analytics.html

CME FedWatch Tool

Probabilities of rate moves at upcoming FOMC meetings implied by 30 day Fed Funds futures

https://www.cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html

CME TreasuryWatch Tool

Snapshot of yields, auctions & issuance, Fed balance sheet & volatilities.

https://www.cmegroup.com/tools-information/quikstrike/treasury-watch.html