Eurodollar vs. SOFR: A Look at Interest Rates

Interest Rates markets are changing with the exit of Eurodollars and the entry of SOFR contracts. The Eurodollar futures contract, a mainstay in financial markets for decades, is set to be discontinued. SOFR has taken the place of Eurodollars and this post will describe both financial contracts and how they are used.

What are Eurodollar futures?

Eurodollar futures are based on the interest rates offered on US dollar deposits held in banks outside of the US. These contracts are used by traders and investors to hedge against interest rate risk. But also, to speculate on interest rate movements, and manage cash flows.

Why is CME discontinuing the contract?

The Eurodollar futures market has been in decline for years, as traders and investors have shifted to other interest rate futures contracts, such as those based on the Federal Reserve’s benchmark interest rate. In a statement announcing the decision, CME said that “market participants have migrated to other futures contracts that better align with their hedging and trading needs.”

What does this mean for financial markets?

The discontinuation of the Eurodollar futures contract is unlikely to have a major impact on financial markets. The contract has already been in decline for years. And, other interest rate futures contracts have become more popular among traders and investors. However, the move does highlight the changing dynamics of financial markets. But also the need for exchanges to adapt to meet the needs of market participants.

What are the implications for traders and investors?

Traders and investors who currently use Eurodollar futures to hedge against interest rate risk or speculate on interest rate movements will need to find alternative contracts to achieve their goals. Fortunately, there are many other interest rate futures contracts available, including those based on the Federal Reserve’s benchmark interest rate, as well as futures contracts based on other currencies, such as the British pound and the Japanese yen.

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Eurodollars to SOFR

The discontinuation of the Eurodollar futures contract is a sign of the changing times in financial markets. Eurodollar contracts have been declining for years. So, the change is unlikely to have a major impact on financial markets. But it does highlight the need for exchanges to adapt to meet the needs of market participants. Investors currently using Eurodollar futures will need to find alternative contracts to achieve their goals. Fortunately, the SOFR has stepped in to take its place.

Secured Overnight Financing Rate (SOFR)

In 2017, the Federal Reserve announced its plans to replace the London Interbank Offered Rate (LIBOR) with a new benchmark interest rate: the Secured Overnight Financing Rate (SOFR).

Here’s what you need to know about SOFR:

What is SOFR?

SOFR is a benchmark interest rate that is based on transactions in the U.S. Treasury repurchase market. It is calculated and published each business day by the Federal Reserve Bank of New York. SOFR represents the cost of borrowing cash overnight using Treasury securities as collateral and represents that rate investors can expect from t-bills.

Why was SOFR created?

SOFR is a response to concerns about the reliability of LIBOR, which has been subject to manipulation in the past. As LIBOR is widely used to set interest rates on loans, mortgages, and derivatives. SOFR ensures the stability and fairness of the financial system.

How is SOFR calculated?

SOFR is based on overnight repurchase agreement transactions in the U.S. Treasury market. The rate is a volume-weighted median of transaction-level tri-party repo data from the Bank of New York Mellon, Clearing House, and FICC GCF Repo.

What are the benefits of SOFR?

One of the key benefits of SOFR is that it is based on actual transactions in the Treasury repurchase market, making it a more reliable and transparent benchmark than LIBOR. Additionally, SOFR is less susceptible to manipulation, as it is based on a large and diverse set of transactions.

How is SOFR used?

SOFR is used as a benchmark interest rate for a variety of financial instruments, including futures contracts, options, and swaps. It is also used as a reference rate for loans and mortgages.

Why care about interest rates?

Interest rates play a crucial role in the functioning of financial markets, and as such, it is important for investors to pay close attention to interest rate markets. Here are a few reasons why:

1. Impact on borrowing and lending: Interest rates determine the cost of borrowing money and the return on lending money. When interest rates are low, borrowing becomes cheaper, which can stimulate economic growth by encouraging businesses and individuals to invest and spend. Conversely, when interest rates are high, borrowing becomes more expensive, which can slow economic growth.
2. Influence on asset prices: Interest rates can have a significant impact on the prices of financial assets, such as stocks, bonds, and real estate. When interest rates are low, investors may be more willing to invest in these assets, as the returns on other types of investments, such as savings accounts, are also low. This can drive up the prices of these assets. On the other hand, when interest rates are high, investors may be less willing to invest in these assets, as the returns on other types of investments are also high, which can drive down the prices of these assets.
3. Effects on currency exchange rates: Interest rate differentials between countries can affect the value of their respective currencies. When interest rates in one country are higher than in another, investors may be more likely to invest in that country’s currency, as they can earn a higher return. This can cause the value of that currency to appreciate relative to other currencies.
4. Indicators of economic health: Interest rates can be a useful indicator of the health of an economy. Central banks often adjust interest rates to manage inflation, which can signal whether an economy is growing or contracting. Additionally, changes in interest rates can reflect changes in the outlook for an economy, such as changes in consumer spending or business investment.

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