October 2020

The pandemic forced central banks across the world to change their trajectories. The UK, EU and US responded with unprecedented monetary policy that sought to soften the effects of government shutdowns and revitalize economies. While activity has normalized somewhat, a resurgence of COVID-19 cases continues to weigh on market sentiment and investors are looking for ways to hedge and manage their risk.

The UK

Even before COVID, the Bank of England (BOE) had forecast slower GDP growth for the UK. As the pandemic moved across Europe, the bank slashed interest rates - from 0.75% to 0.1% - and analysts don’t anticipate any change to rates in the medium term. In addition, the central bank remains open to the use of negative interest rates and has injected £745 billion into its quantitative easing program.

On top of the challenges posed by the global health crisis, there is ongoing uncertainty surrounding Brexit. The UK and the EU have yet to reach a comprehensive agreement on their future relationship with only a few months to go until the transition period ends on December 31, 2020.

Meanwhile, bank participation in SONIA is rising as the December 2021 LIBOR transition deadline approaches. ICE is home to 70% of SONIA market open interest - since the start of September, three-month ICE SONIA Futures are setting OI records almost on a daily basis and are now approaching £80 billion, while cumulative notional traded in SONIA futures exceeded £11 trillion at the end of the third quarter. Inter-contract spreads also saw record performance, with 8% spreads on three-month SONIA futures and Short Sterling traded in September. SONIA options are also in the pipeline, subject to completion of regulatory processes. These options will add additional range and functionality in well-established short-term interest rate markets.

On top of the challenges posed by the global health crisis, there is ongoing uncertainty surrounding Brexit. The UK and the EU have yet to reach a comprehensive agreement on their future relationship with only a few months to go until the transition period ends on December 31, 2020.

The eurozone

The European Central Bank (ECB) had little room to reduce rates at the beginning of the year, which have been negative since 2014. While the ECB had been seeking to normalize monetary policy by increasing interest rates for years, the pandemic forced it to stay the course. Forward guidance from the bank suggests current rate policy will remain in place until inflation reaches ~2%.

In response to the crisis, the ECB pledged to lend freely and purchase more government debt - it increased its Asset Purchase Program (APP) to €120 billion and launched the €750 billion Pandemic Emergency Purchase Protection Program (PEPP). Risk spreads (the spread over 10-year national bonds) tightened after the ECB announced these programs, suggesting that market participants believe that the ECB may have helped avoid a more dire financial crisis.

Strong euro appreciation presents an unexpected hurdle for the bloc, with analysts noting that a stronger euro could impact inflation in the long run. While ECB continues to monitor currency strength, the exchange rate falls outside the bank’s official mandate.

EURIBOR interest futures reached 690,357 in average daily volume and achieved almost €3.4 million in open interest by the end of the third quarter. Interest and trading volumes for ICE’s European interest rate products continues to be strong.

In the US

Early in 2020, market participants were pricing in one or two interest rate cuts from the US Federal Reserve (Fed) arguing that the outlook for global growth was slowing and lower interest rates would stimulate the economy. Beginning in March, as a direct response to the COVID-19 pandemic, the Fed cut the federal funds rate to 0% to 0.25%, introduced numerous regulatory and supervisory actions, and funding, credit, liquidity and loan facilities. The Fed has also vigorously pursued quantitative easing.

The rate banks pay to borrow from each other dropped dramatically over the course of several weeks in March - from between 1.50% to 1.75% to between 0% and 0.25% - and the Fed announced in September that it did not plan to increase interest rates until at least 2023. In August, the bank announced that it would allow periods of higher inflation to compensate for periods of lower inflation - a dramatic shift from the operating framework it established in 2012.

Amid a growing number of cases in the country, Fed Chair Powell has repeatedly emphasized that the future of the US economy depends on the nation’s ability to keep the virus under control and policy decisions at all levels of government. Other uncertainties will likely affect the Fed’s outlook over coming months, including the upcoming US election and lingering tensions with China.

August and September set records for ICE SOFR futures activity, with $1.8 and $1.7 trillion notional trading, respectively. Since the beginning of the year through the end of September, 59% of three-month SOFR market volume has been executed on ICE. ICE continues to build out its STIR products and offers one- and three-month SOFR futures contracts. Packs and Bundles and ICS for 3-month SOFR and Eurodollar futures are also available in the Central limit order.

ICE’s global contracts span geographies, currencies and tenors to provide effective tools to manage risk in a capital efficient manner. These highly liquid contracts enable greater margin efficiencies and increased trading and hedging opportunities across currency curves.