Low rates and FI
How does the current environment affect Fixed Income trading? Is having low and predictable rates helping or hurting the FI trading desks?
How does the current environment affect Fixed Income trading? Is having low and predictable rates helping or hurting the FI trading desks?
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the "low and predictable rates" only exist in the front end of the curve (0-3 years).
The Fed sets the overnight interest rate between banks (Fed Funds Rate).
Imagine a customer at JP Morgan has $1 million in their bank account.
Then JP Morgan uses that 1mm to make a loan to customer B for 900k
Customer B then deposits the 900k loan proceeds into their account at Citibank.
At this moment, Citibank now has 900k of "excess reserves" and JPM has a deficit of 900k of reserves.
So, Citi will lend JPM 900k overnight. Guess what interest rate that loan will be at? The Fed Funds Rate.
Since banks know they will be borrowing those deficit reserves at the Fedfunds rate...they want to loan the $$ to customer B at some interest rate above the FedFunds Rate. Since all banks will be borrowing at essentially the same FedFunds rate, they then compete amongst each other to offer the lowest interest rate to their customers, taking into account credit worthiness (ability to pay back the loan) + value of loan collateral...because banks make money by lending at a higher rate than their own funding costs...known as the NIM (net interest margin)....and this is how the FedFunds rate has an effect on the economy...by setting the baseline for bank lending.
So, that is where the FedFunds rate is used...for overnight loans (banks go thru this process every day with their funding desks....it gets more complicated...but this is the core you need to understand).
Typically, the Fed does not provide extended forward guidance and there is normally uncertainty around what the FedFunds rate will be 3-6 months into the future and beyond....but right now the Fed has committed to the current 0-25 basis point range, in reality averaging at 13 basis points every day, for the next 3 years (and in practice, probably more like 5 years).
However, the Fed Funds Rate does not determine the 30yr bond yield....that thing swings around like a maniac, based on the market excpectation of future inflation and economic growth...and since nobody can predict what will really happen over the next 30 years, there is a high degree of uncertainty....and thus, volatility.
So, you can still actively trade the 30yr bond, and it has plenty of volatility...and is not "predictable" at all.
Look at the UB futures contract to see (which you can trade with 10x leverage)
thank you!
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