(Bloomberg Opinion) — A cornerstone of the US interest rate market for a generation of traders will mostly cease to exist after Friday.
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As part of the long-planned transition away from scandal-plagued London interbank offered rate lending benchmarks, derivatives linked to them will also be phased out. That means Eurodollar futures and options, for decades the bread and butter of those who bet on Federal Reserve decisions or hedging moves in short-term interest rates, will soon be gone.
Friday is when CME Group Inc., the broker that lists the contracts, will convert those due after June into futures or options on the overnight guaranteed funding rate, which have outpaced Eurodollars in trading volume. SOFR is a relatively new benchmark that officials favor as a successor to Libor in dollar funding markets.
“It’s the end of an era,” said Paul Muoio, chief executive of Yellowhook Capital, who began trading futures in 1987 and ran a sales desk at Citigroup Inc. until 2014.
Eurodollars debuted in 1981 and became the CME’s largest product in terms of volume and open interest in 1988. They are futures on the US dollar Three-month Libor, a decades-old benchmark rate for bonds, loans and other forms of credit. Its disappearance is the result of evidence emerging since 2008 that Libor had been rigged by the lenders who contributed the rates used to calculate it.
A panel of industry representatives and regulators chose SOFR to replace the US dollar Libor in 2017. The regular publication of the three-month Libor will end on June 30, although a synthetic version will be available until September 2024.
Under plans under development since 2019, eligible Eurodollar futures will be converted to SOFR equivalents with a fixed spread of 26,161 basis points. That figure was established through the historical difference between Libor, an unsecured rate, and SOFR, which is based on guaranteed loans and published by the New York Federal Reserve. Options will convert based on their strike prices.
Read: Synthetic Libor rate could help some postpone an inevitable transition
Traders and investors have used Eurodollar futures and options, and now their SOFR counterparts, to express predictions for US monetary policy, because the rates they reference are influenced by the interest rate set by the Reserve. Federal. While CME also trades futures in the federal funds rate, trading volume in that commodity has generally trailed Eurodollar and SOFR futures volumes by wide margins, making it a less efficient market.
High levels of uncertainty about the Fed’s policy course following nine rate hikes since March 2022 have helped SOFR activity surge this year.
The end of Eurodollars would have been inconceivable before 2008, when lots of 25,000 to 50,000 were routinely traded, Muoio said. He said his biggest Eurodollar trade was 96,000 contracts.
“I would have said ‘No, cuss, way,'” he said.
Most users of short-term interest rate futures and options have already switched to SOFR from Eurodollars. According to CME, open interest on SOFR products is around 50 million, while open interest on Eurodollars scheduled for conversion dropped to around 7 million as of last week. It peaked at nearly 85 million in June 2019.
Options on Eurodollar and SOFR futures are the only remaining products for which CME still maintains a trading floor in Chicago, although they are also traded on its electronic platform.
(Corrects the synthetic Libor end date in the sixth paragraph.)
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