Central Bank Divergence Is Driving EU Rates Activity

In a highly anticipated meeting, the U.S. Federal Reserve announced on Dec. 16 that it's raising the Federal Funds target to 0.25-0.5. This marks the first policy tightening from the Fed in 9 years.

Article Highlights

As the Fed raises interest rates for the first time in nine years, we take a look at what’s been happening in the ICE short-term interest rate markets.

  • On Dec. 3, the European Central Bank (ECB) cut the deposit rate; on Dec. 16, the U.S. Federal Reserve raised rates, marking a distinct policy divergence.
  • Attention is now turning to the Bank of England (BoE) and the direction of UK interest rates.
  • Macroeconomic changes have resulted in strong volume and open interest trends in short-term interest rate (STIR) futures and options, such as Euribor® and Sterling, and even in medium-term rates like the Gilt contract.
  • ICE's interest rates franchise supports hedging across the full interest rate curve, with contracts from 3 months to 30 years, as well as ERIS futures.

The Fed’s Dec. 16 decision comes on the heels of ECB President Mario Draghi’s announcement on Dec. 3 of a 10-basis point cut to the ECB’s deposit rate, bringing it to a low of -0.3% (down from -0.2%), and an extension to the Eurozone’s existing quantitative easing (QE) program.1 While markets have historically seen the UK follow the U.S., such policy cross-winds highlight the challenge ahead for the central banks. Earlier in 2015, Bank of England's Mark Carney stated that “interest rates would come in to sharper relief at the turn of the year”, however, he more recently noted that a rate hike is a “possibility and not a certainty”.

Trading Activity During Policy Shifts

With central banks across the globe continuously evaluating their respective monetary policies, trading activity in interest rates, which has been flat in recent years, is rising. Firms are evaluating their trading and hedging activities in the interest rates market as they prepare for market-based and macroeconomic changes.

ICE's short-term interest rate (STIR) volume and open interest, which most notably includes Euribor and Short Sterling futures and options, has increased significantly since the first quarter. STIR options traded over 10 million contracts in November, making it the best month in two years, and volume growth has been broad based across ICE Euribor, Short Sterling and Euroswiss interest rate contracts. The combined open interest across STIR futures and options is currently over 20 million contracts.

Hedging Macroeconomic Change in the Interest Rates Market

While the impact of the Fed’s decision whether to raise U.S. interest rates will likely be felt across all contracts traded in U.S. dollars (including the ICE U.S. Dollar Index, global oil contracts and cross currency contracts), the spotlight is on the interest rates market.

A Case Example: Euribor

The 17 countries that make up the Eurozone economic area are working towards maintaining inflation rates at levels below but close to 2%. At this month’s ECB meeting, Draghi reported that the Eurozone would achieve their inflation goals by decreasing deposit rates, extending the asset purchase program into 2017, including local euro area debt in the program, and by reinvesting principal payments on securities purchased in the QE plan. 2

In the weeks leading up to the Dec. 3 ECB monetary policy meeting where Draghi announced the rate cut, monthly volume in ICE Euribor options hit a two-year high of 7 million contracts traded in the month of November. Following the ECB’s announcement, Euribor futures weekly volumes topped 6 million contracts as traders sought hedging solutions to manage anticipated changes in price risk as a result of rates changes.

GBP Rates In Focus

Excluding times of increased volume related to commentary by the Bank of England, trading volumes for UK interest rates futures have been more muted in the years following the global financial crisis as a result of the country’s low and stable interest rate policy. However, that may change now that the ECB and Fed have announced diverging monetary policies. As speculation around the Bank of England’s next move grows, we’re seeing market participants increasing their allocations in GBP rates as they seek more active hedging activities against the risk that the Bank of England could move policy rates.

Short Sterling futures, for example, hit an end-of-month record open interest high in November of 3,573,424, and average daily volume in excess of 500k contracts, with current open interest standing in excess of 3.6 million contracts (as of 13 December 2015).

Similarly, activity in Gilt futures remains strong on the back of the changing interest rate environment, with average daily volume up +7% (YoY) and open interest up +6% (YoY).

With interest rate contracts ranging from three months to 30 years, the ICE interest rates franchise is structured to support risk management needs across the full curve. As monetary policies continue to shift around the globe, we’re focused on providing the hedging solutions traders need to effectively manage price risk throughout the current period of economic change.

ICE Interest Rate Products


1 Introductory Statement to the Press Conference (with Q&A), European Central Bank. 3 December 2015. https://www.ecb.europa.eu/press/pressconf/2015/html/is151203.en.html

2 http://www.federalreserve.gov/faqs/currency_12773.htm