For many years post-recession, the Fed Funds curve was dead.  Then as whispers of Fed policy normalization came around, the Fed Funds within 6 months started to come alive.  Then the Fed Funds within one year were trading actively.  I was surprised to see that the volumes even past one year are finally showing signs of life.  On the right are the open interests in Fed Funds futures from this time the past three years.  There are a number of things to note:

  • The open interest has steadily increased the past few years. The FFF9 OI of 309K is fairly high compared to the EDZ8 OI of 2,077K (14.9%).  In 2016, the FFF7 OI was 51K compared to an EDZ6 OI of 1,427K (3.6%).  Part of the increasing interest in FFs futures was probably just evolution as we progressed through the hiking cycle.  But a larger part of the increase in Fed Funds activity is undoubtedly the unpredictability of Libor, and Kong distorting the 2019 part of the curve.  People want to take risk based on their Fed views, and my not want exposure to extraneous noise beyond their control.
  • We are seeing noticeably larger interest in the FF contracts that represent Fed quarterly meeting plays. The F, J, N and V “quarterly” futures all represent the cleanest possible expression of the FFER right after the Dec, Mar, Jun and Sept Fed meetings.  In previous years, the open interest in the FFs contracts had been relatively evenly-spread.  This effect could give some support to the notion that the Fed Funds futures are being used where EDs were used previously.
  • The increase in use of “quarterly” FF futures could also indicate a wider use as part of Overnight Index Swap (or ED-FF spread) trades. You can approximate the Fed meeting exposure of a quarterly ED[x] contract, by taking the average of FF[x+1] and FF[x+2].  For example, EDM8 can be approximated using an average of FFN8 and FFQ8.  There will be ED-FF spread widening/narrowing risk, but the net Fed meeting exposure will be negligible if you buy/sell EDs and sell/buy FFs. In these times where the non-quarterly meeting pricing has been (mostly) negligible[1], one can simply just use either FF[x+1] or FF[x+2] for transactional simplicity.  The stability with which the ED spreads vs FF spreads trade makes me think there are some folks out there more actively trading the OIS than in previous years.  However, overly aggressive ED-FF trading could be distorting the relatively lighter-traded FF contracts.
  • The next most-traded FF contracts are the contracts after the quarterly contracts. This also supports the theory that there is more OIS (or ED-FF spread) trading.  But we have also seen large volumes go through in non-quarterly meeting plays (FFF-G, FFJ-K, FFN-Q and FFV-X).  The largest catalyst for the non-quarterly meeting pricing is going to be whether the Fed goes to press conferences at each meeting.  That would noticeably increase the non-quarterly meeting pricing – especially relative to the quarterly meeting pricing.  It’s unclear the Fed is going to need to have press conferences at every meeting, while they are still hiking “gradually.”  As they approach the neutral rate, they will be less active, and will not need to adjust policy very often.  So you would expect the pricing of the non-quarterly meetings to decline the closer we get to the longer term FF rate.

This new longer end FF vehicle gives us some new opportunities we didn’t have in EDs, that I will discuss in the Trade Thoughts section…

[1] Other than a few strange times, like in Q1, where some thought Powell could have press conferences every meeting.