Interest Rate Market Monitor 2nd Quarter 2013

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CME Group offers interest rate futures and options that allow one to engage in trading activities driven by such factors as outright yield movements, changes in the shape of the yield curve, dynamic credit risks and volatility considerations. This report reviews these factors as they played out in the most recently completed calendar quarter and the impact they have exerted on CME Group interest rate products.

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Interest Rate Market Monitor 2nd Quarter 2013

  1. 1. INTEREST RATES InterestRateMarketMonitor 2nd Quarter2013 JULY 8, 2013 John W. Labuszewski Michael Kamradt Managing Director Executive Director Research & Product Development 312-466-7469 jlab@cmegroup.com Interest Rate Products 312-466-7473 michael.kamradt@cmegroup.com
  2. 2. 1 | Interest Rate Market Monitor 2nd Quarter 2013 | July 8, 2013 | © CME GROUP Fixed income market participants may trade based upon performance expectations couched along several dimensions including outright yield movements, changes in the shape of the yield curve, dynamic credit risks as well as volatility considerations. CME Group offers interest rate futures and options that allow one to engage in trading activities driven by any of these significant factors. Our offerings includes Eurodollar, Treasury, Fed Funds, Swap and other interest rate products covering the entire spectrum of the yield curve, representing both public and private credit risks. Further, our offerings include options on the most popular of our interest rate futures contracts. This document represents a review of these factors as they played out in the most recently completed calendar quarter and the impact they have exerted on CME Group interest rate products. We begin with a review of fundamental economic conditions as a backdrop of how this impacts upon outright yield movements, the shape of the curve and credit considerations. Growth and Employment Taking our cue from the Federal Reserve’s most recent observations on the economy, we find “that economic activity has been expanding at a moderate pace. Labor market conditions have shown further improvement in recent months, on balance, but the unemployment rate remains elevated.” 1 1st quarter 2013 growth was most recently reported at +1.8% - although that figure has been steadily revised downward from its advance estimate of 2.5% and the preliminary estimate of 2.4%. Unemployment has been generally declining in 2013 although we took a step back as the May 2013 figure up-ticked to 7.6% from April’s 7.5%. Labor force participation remains very low at only 63.4% in May although this represents an improvement from the trough of 63.3% recorded in March. 1 Federal Reserve Press Release dated June 19, 2013. The Fed further observes that “household spending and business fixed investment advanced.” 2 These developments are reflected in retail sales figures which advanced to $181.7 billion in May and up 2.9% on a year-on-year basis from the previous May. The Industrial Production Index has advanced 1.61% over the same year-on-year period. However, it has down-ticked a few notches from a recent peak of 99.0584 in March to May’s 98.6709. This is further reflected in a downtick in capacity utilization from a recent peak of 78.1% in March to 77.6% in May. 2 Ibid. 4% 5% 6% 7% 8% 9% 10% 11% -10% -8% -6% -4% -2% 0% 2% 4% 6% Q105 Q305 Q106 Q306 Q107 Q307 Q108 Q308 Q109 Q309 Q110 Q310 Q111 Q311 Q112 Q312 Q113 UnemploymentRate QtrlyChangeinGDP Growth and Employment Real GDP (SA) Unemployment Rate Source: Bureau of Economic Analysis (BEA) & Bureau of Labor Statistics (BLS) 63% 64% 65% 66% 67% 4% 5% 6% 7% 8% 9% 10% 11% Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 LaborForceParticipation UnemploymentRate Employment Statistics Unemployment Rate Labor Force Partcipation Source: Bureau of Labor Statistics (BLS)
  3. 3. 2 | Interest Rate Market Monitor 2nd Quarter 2013 | July 8, 2013 | © CME GROUP While industrial sector activity remains below the pre-subprime crisis peak, corporate profitability has soared to new all-time highs by a wide margin. 1st quarter profitability increased some 4.7% although this represents a slow-down from the previous 4 quarters. The Fed goes on to suggest that the “housing sector has strengthened further.” 3 This is reinforced by an 11.58% advance in the S&P/Case-Shiller 10-City Composite Housing Index in April on a year-on-year basis from the previous April. This represents the strongest performance observed in this Index since early 2006 and prior to the onset of the subprime mortgage crisis which saw residential home values plummet beginning in mid-2006. 3 Ibid. Inflation The FOMC’s statement goes on to say “[p]artly reflecting transitory influences, inflation has been running below the Committee’s longer-run objective, but longer-term inflation expectations have remained stable … The Committee also anticipates that inflation over the medium term likely will run at or below its 2 percent objective.” 4 The Consumer Price Index (CPI) was reported to have advanced 1.4% on a year-on-year basis in May 2013. Core inflation, excluding volatile food and energy prices, rose 1.7% over the same period. Thus, by any measure, inflation is relatively muted. 4 Ibid. 1.20 1.25 1.30 1.35 1.40 1.45 1.50 $150 $155 $160 $165 $170 $175 $180 $185 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Inventory:SalesRatio RetailSales(Bil$) Retail Sector Activity Real Retail Sales & Food Services SA Total Business Inventory:Sales Ratio Source: U.S. Census Bureau 66% 68% 70% 72% 74% 76% 78% 80% 82% 80 85 90 95 100 105 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 CapacityUtilization IndustrialProductionIndex Industrial Sector Activity Index of Industrial Production Capacity Utilization Source: St. Louis Federal Reserve FRED Database $0 $200 $400 $600 $800 $1,000 $1,200 $1,400 $1,600 $1,800 $2,000 -60% -40% -20% 0% 20% 40% 60% 80% 100% 120% Q104 Q404 Q305 Q206 Q107 Q407 Q308 Q209 Q110 Q410 Q311 Q212 Q113 Pre-TaxProfits(Billions) AnnualizedChange U.S. Corporate Profitability Annual Change Corporate Profits (Bil) Source: Department of Commerce 80 120 160 200 240 280 320 Jan-00 Nov-00 Sep-01 Jul-02 May-03 Mar-04 Jan-05 Nov-05 Sep-06 Jul-07 May-08 Mar-09 Jan-10 Nov-10 Sep-11 Jul-12 May-13 S&P/Case-Shiller Housing Indexes Los Angeles San Diego San Francisco Denver Washington DC Miami Chicago Boston Las Vegas New York Comp-10 Source: Standard & Poor's
  4. 4. 3 | Interest Rate Market Monitor 2nd Quarter 2013 | July 8, 2013 | © CME GROUP Monetary Policy To the extent that “[t]he Committee expects that, with appropriate policy accommodation, economic growth will proceed at a moderate pace and the unemployment rate will gradually decline toward levels the Committee judges consistent with its dual mandate,” monetary policy remains virtually unchanged. 5 “In particular, the Committee decided to keep the target range for the federal funds rate at 0 to ¼ percent and currently anticipates that this exceptionally low range … will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.” 6 While the Committee restated its determination to stay this course, it significantly did not mention a period of time over which it expects to maintain Fed Funds at its current levels. While Fed Funds has served as the primary tool of monetary policy, the FOMC’s asset repurchase programs (aka Quantitative Easing or “QE”) have exerted a significant dampening effect on longer- term yields. Many analysts have suggested that the 5 Ibid. 6 Ibid. Fed may be preparing to discontinue or at least reduce the scale of this stimulus. This suggestion is based upon indications of Fed flexibility regarding these policies as Fed Chairman Bernanke has suggested that the Fed “is prepared to increase or reduce the pace of its asset purchases to ensure that the stance of monetary policy remains appropriate as the outlook for the labor market or inflation changes.” 7 As a result, we have seen 10- year Treasury rates rally from 1.85% at the conclusion of the 1st quarter to just over 2.5% as of this writing. Still, the Committee’s most recent statement suggests that will “continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month … maintaining its existing policy of reinvesting principal payments from its holdings … and rolling over maturity Treasury securities at auction.” 8 Fiscal Policy The fiscal stimulus implicit in the 2009, 2010 and 2011 Federal budget deficits of $1.4 trillion, $1.3 trillion and another $1.3 trillion, respectively, has shrunk to $1.1 trillion in 2012. Further restraint in 7 Testimony of Chairman Ben S. Bernanke on the Economic Outlook before the Joint Economic Committee, U.S. Congress, Washington D.C. (May 22, 2013). 8 Op cit, Federal Reserve Press Release dated June 19, 2013. -3% -2% -1% 0% 1% 2% 3% 4% 5% 6% Jan-04 Sep-04 May-05 Jan-06 Sep-06 May-07 Jan-08 Sep-08 May-09 Jan-10 Sep-10 May-11 Jan-12 Sep-12 May-13 Year-on-YearChange Consumer Price Index (CPI) CPI - All Urban Consumers SA CPI ex-Food & Energy SA Source: Bureau of Labor Statistics (BLS) 0% 1% 2% 3% 4% 5% 6% 7% Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Benchmark U.S. Rates Target Fed Funds 2-Yr Treasury 5-Yr Treasury 10-Yr Treasury 30-Yr Treasury
  5. 5. 4 | Interest Rate Market Monitor 2nd Quarter 2013 | July 8, 2013 | © CME GROUP early 2013 is also in evidence. As such, the FOMC concedes that “fiscal policy is restraining economic growth.” 9 Fed Chairman Bernanke elaborates on this point, suggesting that “the expiration of the payroll tax cut, the enactment of tax increases, the effects of the budget caps on discretionary spending, the onset of the sequestration, and the declines in defense spending for overseas military operations are expected, collectively, to exert a substantial drag on the economy … [that is estimated to] slow the pace of real GDP growth by about 1-1/2 percentage points during 2013, relative to what it would have been otherwise.” But the Congressional Budget Office (CBO) has indicated that “under current policies, the federal deficit and debt as a percentage of GDP will begin rising again in the latter part of this decade and move sharply upward thereafter, in large part reflecting the aging of our society and projected increases in health-care costs, along with mounting debt service payments.” 10 Still, we note that the CBO’s projections regarding fiscal policy, as of May 2013, are much rosier than they were a scant two years ago in 2011. The current CBO baseline forecast has the ratio of Federal debt to GDP rising from 2012’s 71.9% to only 73.6% by 2023. Their most pessimistic 9 Ibid. 10 Op. cit., Testimony of Chairman Ben S. Bernanke (May 22, 2013). alternative forecast released in 2011 had that ratio climbing to 109.0% by 2023. While the impact of restrained fiscal policies may represent a short-term drag on GDP, the longer-term benefits seem obvious. Current & Capital Account Flows The 1st quarter 2013 current account deficit increased to $106.1 billion or 2.7% of GDP. This represents a slight setback from the revised 4th quarter report of a $102.3 billion deficit, or 2.6% of GDP. While the current figure was a downtick, the situation nonetheless is much improved from the previous year or certainly from the pre-subprime crisis period. Another interesting source of flow of funds data may be found in the U.S. Treasury Department’s Treasury International Capital (or “TIC”) database. This database tracks flows into and out of the U.S. The data is broken into foreign stocks, foreign bonds, U.S. stocks, U.S. corporate bonds, U.S. government agencies and U.S. Treasuries. U.S. vs. overseas capital flows have generally been characterized over the past decade by substantial influx of funds into U.S. Treasuries. This phenomenon peaked in 2010 as overseas investors purchased some $704 billion in U.S. Treasuries on a net basis. The figure tailed off to $433 and $417 billion in 2010 and 2011, respectively, but that still represents sizable values. 0% 20% 40% 60% 80% 100% 120% 1940 1950 1960 1970 1980 1990 2000 2010 2012 Est14 Est16 Est18 Est20 Est22 US Gross Public Debt as % of GDP Debt as % GDP (NSA) CBO Forecast May-13 CBO Alt Forecast 2011 Source: Congressional Budget Office -$250 -$200 -$150 -$100 -$50 $0 Q104 Q304 Q105 Q305 Q106 Q306 Q107 Q307 Q108 Q308 Q109 Q309 Q110 Q310 Q111 Q311 Q112 Q312 Q113 U.S. Current Account Deficit (Billions USD) Source: Bureau of Economic Analysis (BEA)
  6. 6. 5 | Interest Rate Market Monitor 2nd Quarter 2013 | July 8, 2013 | © CME GROUP But during the first four months of 2013, foreign investors sold some $14 billion of Treasuries on a net basis. Some $37 billion in capital has flowed out of the U.S. on a net basis through April 2013. While the U.S. current account deficit remains substantial, it appears that foreign investors are become reticent to increase U.S. capital market holdings. Certainly this is motivated by the prospects of rising rates and declining Treasury values in the face of at least modest economic recovery. Outright Yield Movements Interest rates have started to come off of the extreme lows that have been observed in recent months and years. Still, we remain at reasonably low levels. Should economic recovery continue and if the Fed should, as a result, discontinue its stimulus in the form of asset repurchase programs, it is certainly conceivable that further rate advances may be forthcoming. This implies declining fixed income asset values and represents a further source of global risk as explained in more detail below. We might measure the prospective risk of rising rates by resorting to an analysis known as “breakeven (B/E) rate analysis.” This technique addresses the questions – how much do rates need to advance, measured in basis points (bps), before investors suffers a loss by holding a particular security or portfolio? In order to address this question in a current context, we examined the characteristics of various indexes as published by Barclays Capital including the U.S. Treasury Index (inclusive of all maturities); the Intermediate Treasury Index (1-10 year maturities); the Long Treasury Index (10+ year maturities); and the Aggregate Index (includes mortgages and corporates). This analysis is generally conducted over a twelve- month time horizon and takes into account any income generated by holding the security. One may estimate the rate advance required to offset income over a 12-month period by simply dividing the yield on the index by its duration. Breakeven Rate Analysis (6/28/13) Barcap Index 2013 YTD Return Duration (Years) Yield B/E Rate Advance U.S. Treasury -2.11% 5.2 1.23% 24 bps Intermediate Treasury -1.28% 3.7 0.96% 26 bps Long Treasury -7.83% 16.3 3.30% 20 bps Aggregate -2.44% 5.2 2.35% 45 bps E.g., if rates advance 24 basis points (bps) or 0.24% on all securities in the U.S. Treasury Index over the course of the next 12 months, the returns associated with the index will equate to zero, or the breakeven point. This is calculated as the yield in basis points divided by duration or 24 bps (=123 bps ÷ 5.2 years). E.g., the breakeven rate advance for intermediate Treasuries is 26 bps (=96 bps ÷ 3.7 years). -$800 -$300 $200 $700 $1,200 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Thru4/13 Net US/Foreign Capital Flows (Billions USD) US Treasuries US Gov't Agencies US Corporates US Stocks Foreign Bonds Foreign Stocks Source: U.S. Treasury TIC Database 0 50 100 150 200 250 U.S. Treas Inter Treas Long Treas Aggregate Breakeven Rate Analysis (Basis Points) Dec-99 Dec-07 Dec-12 Jun-13 Source: Bloomberg
  7. 7. 6 | Interest Rate Market Monitor 2nd Quarter 2013 | July 8, 2013 | © CME GROUP E.g., the breakeven rate advance for long-term Treasuries is 20 bps (=330 bps ÷16.3 years). E.g., the breakeven rate advance for the Barcap U.S. Aggregate Bond Index is 45 bps (=235 bps ÷ 5.2 years). Note that these breakeven rate advances have increased just a bit from their lows in late 2012. Note further, however, that year-to-date 2013 returns are decidedly negative as the Barcap Intermediate Treasury Index is off 1.28% for the year while the Long Treasury Index is down 7.83% for the year. Shape of Yield Curve The Fed reacted quickly and decisively to the subprime crisis by injecting massive liquidity into the system. The target Fed Funds rate was reduced in 2008 from 5-¼% to the current level of zero to ¼%. But after the Fed moved rates (essentially) to zero, it had apparently expended its major monetary policy bullet with little positive impact. Thus, it followed up with more inventive methods, notably its “Quantitative Easing” (QE) programs that continue to target the purchase of $40 billion of mortgage securities and $45 billion in Treasuries on a monthly basis. But more recent events, as described above, suggest that the Fed may relent in its innovative easing programs. Markets reacted by pushing up medium- to long-term yields, focusing on the 10- year sector of the curve which ended the quarter near 2-1/2% - see Table 1 below. This action resulted in those large losses as described above in 2013 on a year-to-date basis. Thus, we have seen a steepening in the curve driven by these rate advances. The economic optimism manifest in notional rates is further reflected in real or inflation-adjusted rates of return. Real yields associated with Treasury Inflation Protected Securities (TIPS) have risen quite a lot from recently recorded extreme lows. The real yield associated with the bellwether 10-year TIPS ended the quarter at 0.53% and up substantially from the -0.64% observed as the conclusion of the 1st quarter. 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 4.0% 3-Mth 6-Mth 1-Yr 2-Yr 3-Yr 5-Yr 7-Yr 10-Yr 30-Yr Treasury Yield Curve Jun-13 Mar-13 Dec-12 Sep-12 Jun-12 Mar-12 Dec-11 Sep-11 -1% 0% 1% 2% 3% 4% 5% Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Treasury Yield Spreads 2-5 Yr Spread 2-10 Yr Spread 2-30 Yr Spread 5-10 Yr Spread 5-30 Yr Spread 10-30 Yr Spread -2% -1% 0% 1% 2% 3% 4% 5% Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 TIPS Yields 5-Yr TIPS 7-Yr TIPS 10-Yr TIPS 20-Yr TIPS 30-Yr TIPS
  8. 8. 7 | Interest Rate Market Monitor 2nd Quarter 2013 | July 8, 2013 | © CME GROUP Credit Risk Credit risk refers to the risk of default associated with a fixed income security, i.e., the risk that the issuer will fail to make timely coupon and principle payments. This risk may be monitored and traded by reference to spreads between instruments bearing divergent credit qualities. E.g., one may compare the yields associated with corporate bonds of varying credit quality to the yields associated with comparable maturity Treasury securities. This represents a classic comparison of private vs. public credit risks. As a rule, of course, the corporate securities should offer a more attractive yield to compensate for the enhanced risk of default. The Moody’s Corporate Bond Indexes cover investment grade securities with credit qualities ranging from Baa to Aaa. Moody’s targets bonds with remaining maturities as close to 30 years as possible. Securities are deleted from the indexes if their remaining maturity falls below 20 years, if the security is susceptible to redemption or if the rating should be amended. By the conclusion of the 2nd quarter 2013, Aaa and Baa corporate bond yields, as measured by the Moody’s Indexes, were up to 4.32% and 5.35%, respectively. This compares to the figures of 3.90% and 4.83% seen at the end of the 1st quarter. These figures might be further be compared to the yields of 2.487% and 3.500% associated with on-the-run (OTR) 10- and 30-year Treasuries. Thus, corporate over Treasury yield spreads appear to be rallying in another sign of an improving economic environment. Fixed income portfolio managers must, of course, decide whether to allocate assets to Treasury or corporate securities. One critical central question becomes – how many basis points must the spread between corporates and Treasuries widen before corporates actually underperform Treasuries? To provide some insight into this question, we may create a simple corporate spread breakeven (B/E) analysis for the Finance sector, as reported by Bloomberg. This process is analogous to our breakeven rate analysis as explained above. Specifically, we divide the finance spread, or the premium in corporate bond rates vs. comparable maturity Treasury rates, by the duration associated with those corporates. The result provides an indication of the degree to which the spread must widen before corporates underperform Treasuries. 5-Year Corporate Finance Spread B/E Analysis (6/28/13) Corporate Quality Duration (Years) Finance Spread vs. Treas B/E Spread Advance AA 4.9 0.82% 17 bps A 4.9 1.01% 21 bps BBB 4.9 1.97% 40 bps BB 4.9 2.20% 45 bps Source: Bloomberg E.g., if the spread for AA corporate bonds should increase by 17 basis points (bps) over the course of the next 12 months, the returns associated with corporates will underperform comparable maturity Treasuries. This is calculated as the finance spread in basis points divided by duration or 17 bps = (82 bps ÷ 4.9 years). E.g., the breakeven spread advance for A-rated corporates is 21 bps (=101 bps ÷ 4.9 years). E.g., the breakeven spread advance for BBB corporates is 40 bps (=197 bps ÷ 4.9 years). E.g., the breakeven spread advance for BB corporates is 45 bps (=220 bps ÷ 4.9 years). 3% 4% 5% 6% 7% 8% 9% 10% Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Moody's Corporate Bond Indexes Moody's Aaa Corp Moody's Aa Corp Moody's A Corp Moody's Baa Corp
  9. 9. 8 | Interest Rate Market Monitor 2nd Quarter 2013 | July 8, 2013 | © CME GROUP While still at relatively low levels, it does appear that breakeven spread levels have turned the corner by coming off their recent all-time lows. Still, that has come at significant cost as returns for corporate bond investment, like Treasuries, are significantly negative on a year-to-date basis. Still, more risk looms as the prospect for further rate advances remains. Other Credit Spreads Two additional and interesting credit quality spreads that bear watching include (1) swap spreads; and, (2) the OIS-LIBOR spread. A swap spread is a reference to a spread between interest rate swaps (IRS) and Treasury securities. Consider this a form of credit spread insofar as it represents a direct comparison between the private credit risks represented in IRS markets vs. public credit risks represented in Treasury markets. Our graphic depicts various swap spreads constructed from data gleaned from the U.S. Treasury Department’s daily H15 report. Thus, we compare 2-, 5-, 10- and 30-year LIBOR-based interest rate swap instruments to “Constant Maturity Treasury” (CMT) yields. These spreads tend to advance and decline as a function of credit conditions and the general level of macroeconomic concerns. Normally, one would expect that the IRS instruments would carry a higher yield than comparable maturity Treasuries. But expected relationships do not always hold. The 30-year swap spread had fallen well into negative territory in the wake of the subprime mortgage crisis, flying in the face of the historical presumption that private credit risks and yields must exceed public risks and yields. Some would suggest acting upon this apparent mispricing by pursuing an arbitrage transaction by buying long-term Treasuries and paying fixed rate on 30-year interest rate swap instruments. But the Fed essentially backstopped the banking industry during the subprime crisis while S&P downgraded the credit rating of U.S. long-term sovereign debt in August 2011, thereby causing the implicit credit risks to converge to a degree. The structure of IRS instruments may imply less risk relative to long-term Treasuries as swaps do not require an original exchange of principal values and may be marked-to-market. Thus, some suggest that the spread belongs in negative territory, representing a proverbial “black swan” in practice. Further explanation for this apparent pricing anomaly may be found in the movement towards liability-driven investment (LDI) strategies. Many pension fund managers have increasingly turned to long-term IRS, as an alternative to 30-year Treasury investment, to match the maturities of their assets with liabilities. But, as a result of glimmers of economic optimism, swap spreads including the 30-year spread have advanced during the 1st quarter. While still in negative territory, the 30-year swap spread 0 50 100 150 200 250 AA A BBB BB Corporate Spread B/E Analysis (Basis Points) Dec-08 Dec-10 Mar-13 Jun-13 Source: Bloomberg -0.6% -0.4% -0.2% 0.0% 0.2% 0.4% 0.6% Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Swap over Treasury Spreads 2-Yr Spread 5-Yr Spread 10-Yr Spread 30-Yr Spread
  10. 10. 9 | Interest Rate Market Monitor 2nd Quarter 2013 | July 8, 2013 | © CME GROUP advanced to -0.04% from the figure of -0.16% seen near the conclusion of 2012. Note that CME Group now offers 2-, 5-, 10- and 30- year deliverable swap futures contracts (DSFs) as well as Treasury futures contracts covering the 2-, 5-, 10- and 30-year sectors of the curve. Thus, one may construct a weighted spread to take advantage of risk-on, risk-off conditions. Credit Quality Increasing Buy DSF / Treasury futures spreads Credit Quality Decreasing Sell DSF / Treasury futures spreads If you believed that economic tensions are dissipating and wanted to adopt an aggressive “risk- on” posture, some suggest buying DSF/Treasury spreads. If you believed that economic tensions might flare up, then one might adopt a conservative “risk-off” position by selling DSF/Treasury spreads. On the short-end of the yield curve, one may monitor the spread between 3-month LIBOR and Overnight Interest Swap (OIS) rates. LIBOR is an acronym for London Interbank Offered Rate and represents the rate paid by commercial banks (in London) on U.S. dollar denomianted deposits. OIS represents the rate paid on overnight deposits by a central bank such as the U.S. Federal Reserve to its member banks, i.e., the Fed Funds rate, as observed and compounded over a period of time such as three months. To the extent that this spread gauges the difference between commercial bank and central bank deposit rates, it reflects the risk of default on the part of commercial banks. This spread has historically been observed around 10 basis points. But it rocketed to 3.5% at the height of the subprime mortgage crisis. While the European sovereign debt crisis does not hit quite so close to home, the spread nonetheless spiked in mid 2010 and is moved up again in 2011 and in reaction the European sovereign debt situation. The LIBOR-OIS spread has actually been quite stable over the course of 2013 to date. It ended the 2nd quarter at 16 basis points and very narrowly changed from the 14 basis points and 16 basis points seen at the end of the 1st and 4th quarters, respectively. This stability is consistent with indications of economic recovery and stabilizing credit conditions. CME Group offers 3-month Eurodollar futures based on the British Bankers Association (BBA) 3-month Eurodollar time deposit rate; and futures based on 30-day Federal Funds rate. Thus, a properly weighted spread between Eurodollar and Fed Funds futures may represent a nice proxy for the 3-month LIBOR vs. OIS spread. Credit Quality Increasing Buy Eurodollar / Fed Funds futures spreads Credit Quality Decreasing Sell Eurodollar / Fed Funds futures spreads If you believed that economic tensions were likely to dissipate and wanted to adopt an aggressive risk-on position, some suggest buying buy Eurodollar/Fed Fund spreads. If you believed that economic tensions might flare up, then one might adopt a conservative risk-off position by selling Eurodollar/Fed Funds spreads. Conclusion CME Group offers a broad array of interest rate futures and option contracts running the gamut from short-term to long-term contracts and reflecting both public to private credit risks. These products provide facile and liquid vehicles with which one may express a view on prospective market movements. Or, to manage the risks associated with fixed income holdings during turbulent times. 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 4.0% Jan-07 Jun-07 Nov-07 Apr-08 Sep-08 Feb-09 Jul-09 Dec-09 May-10 Oct-10 Mar-11 Aug-11 Jan-12 Jun-12 Nov-12 Apr-13 3-Mth LIBOR - OIS Spread
  11. 11. 10 | Interest Rate Market Monitor 2nd Quarter 2013 | July 8, 2013 | © CME GROUP Table 1: Treasury On-the-Runs (OTRs) (As of 6/28/13) Coupon Maturity Price Yield Duration (Years) BPV (per Mil) Yield (Mar-13) Yield (Dec-12) Yield (Sep-12) Yield (Jun-12) 4-Wk Bill 07/25/13 0.008% 0.066 $6.58 0.028% 0.018% 13-Wk Bill 09/26/13 0.033% 0.238 $23.84 0.074% 0.043% 0.073% 0.083% 26-Wk Bill 12/26/13 0.093% 0.488 $48.77 0.104% 0.114% 0.133% 0.153% 52-Wk Bill 06/26/14 0.143% 0.986 $98.63 0.124% 0.140% 0.155% 0.206% 2-Yr Note 3/8% 06/30/15 100-01 1/8 0.349% 1.985 $199 0.244% 0.248% 0.232% 0.303% 3-Yr Note 1/2% 06/15/16 99-18 1/8 0.648% 2.936 $292 0.035% 0.353% 0.307% 0.395% 5-Yr Note 1-3/8% 06/30/18 99-28 7/8 1.395% 4.813 $481 0.765% 0.724% 0.626% 0.719% 7-Yr Note 1-7/8% 06/30/20 99-18 1.942% 6.525 $650 1.238% 1.180% 1.050% 1.106% 10-Yr Note 1-3/4% 05/15/23 93-18 3/4 2.487% 8.945 $839 1.850% 1.758% 1.634% 1.646% 30-Yr Bond 2-7/8% 05/15/43 88-15 3.500% 19.140 $1,700 3.103% 2.950% 2.824% 2.754% Table 2: Treasury OTR Yield Spreads (As of 6/28/13) Jun-13 Mar-13 Dec-12 Sep-12 Jun-12 Yield Spreads 2-5 Yr 1.046% 0.521% 0.476% 0.394% 0.416% 2-10 Yr 2.138% 1.606% 1.510% 1.402% 1.343% 2-30 Yr 3.151% 2.859% 2.702% 2.592% 2.451% 5-10 Yr 1.092% 1.085% 1.034% 1.008% 0.927% 5-30 Yr 2.105% 2.338% 2.226% 2.198% 2.035% 10-30 Yr 1.013% 1.253% 1.192% 1.190% 1.108% Butterflies 2-5-10 Yr 0.046% 0.564% 0.558% 0.614% 0.511% 2-5-30 Yr 1.059% 1.817% 1.750% 1.804% 1.619% Copyright 2013 CME Group All Rights Reserved. Futures trading is not suitable for all investors, and involves the risk of loss. Futures are a leveraged investment, and because only a percentage of a contract’s value is required to trade, it is possible to lose more than the amount of money deposited for a futures position. Therefore, traders should only use funds that they can afford to lose without affecting their lifestyles. And only a portion of those funds should be devoted to any one trade because they cannot expect to profit on every trade. All examples in this brochure are hypothetical situations, used for explanation purposes only, and should not be considered investment advice or the results of actual market experience.” Swaps trading is not suitable for all investors, involves the risk of loss and should only be undertaken by investors who are ECPs within the meaning of section 1(a)18 of the Commodity Exchange Act. Swaps are a leveraged investment, and because only a percentage of a contract’s value is required to trade, it is possible to lose more than the amount of money deposited for a swaps position. Therefore, traders should only use funds that they can afford to lose without affecting their lifestyles. And only a portion of those funds should be devoted to any one trade because they cannot expect to profit on every trade. CME Group is a trademark of CME Group Inc. The Globe logo, E-mini, Globex, CME and Chicago Mercantile Exchange are trademarks of Chicago Mercantile Exchange Inc. Chicago Board of Trade is a trademark of the Board of Trade of the City of Chicago, Inc. NYMEX is a trademark of the New York Mercantile Exchange, Inc. The information within this document has been compiled by CME Group for general purposes only and has not taken into account the specific situations of any recipients of the information. CME Group assumes no responsibility for any errors or omissions. Additionally, all examples contained herein are hypothetical situations, used for explanation purposes only, and should not be considered investment advice or the results of actual market experience. All matters pertaining to rules and specifications herein are made subject to and are superseded by official CME, NYMEX and CBOT rules. Current CME/CBOT/NYMEX rules should be consulted in all cases before taking any action.

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