At quarter-end, US money markets often experience temporary funding pressures. This is due to factors like large Treasury settlements, tax payments, and regulatory reporting dates, which can cause volatility in short-term rates such as the Secured Overnight Financing Rate (SOFR) and the effective Fed funds rate (FF). The spread between these two rates (SOFR/FF) can widen or narrow sharply around these dates 

Why Does the Spread Move?

• Quarter-end effects: Banks and money market funds adjust their balance sheets for regulatory reasons, often leading to a temporary drain in reserves from the system.
• Foreign banks (FBOs): These institutions hold large reserves at the Fed, much of which is funded in repo markets. At quarter-end, they willingly shed reserves as their demand temporarily drops, moving cash into the Fed’s Overnight Reverse Repo Facility (ONRRP). This is a temporary pullback, not a sign of systemic stress.
• Market pricing: As a result, the SOFR/FF spread can become more negative, reflecting perceived funding risk.
• Buy SOFR futures and sell Fed funds futures. As quarter-end passes and funding pressures ease, the spread should narrow (become less negative), allowing the trade to profit.

Trade example:

1. Initiate the Trade:
   • Buy 1 contract 1m SOFR futures.
   • Sell 1 contract 1m Fed funds futures.
   • @ -15bp.
2. Quarter-End Passes:
   • Funding pressures ease.
   • The spread narrows to -10bp (SOFR rises relative to FF, or FF falls relative to SOFR).
3. Close the Trade:
   • Sell the SOFR futures contract.
   • Buy back the Fed funds futures contract.
   • The spread has change of +5.0bp.
4. Profit Calculation:
   • Each basis point move in the spread is worth a fixed amount per contract (depending on contract specs).
   • If the notional value per bp is, for example, $41.67 per contract:
     • Profit = 5bp × $41.67 = $208 per contract 

As global financial markets transition away from LIBOR, the Secured Overnight Financing Rate (SOFR) has emerged as the leading benchmark for USD-denominated short-term interest rates. SOFR futures, particularly those traded on the Chicago Mercantile Exchange (CME), are now essential tools for hedging, trading, and managing interest rate risk.

What Is SOFR?

SOFR is a daily overnight rate based on actual transactions in the U.S. Treasury repo market. It reflects the cost of borrowing cash overnight collateralized by Treasury securities. Unlike LIBOR, SOFR is:
– Transparent: Based on real transactions
– Robust: Covers a broad market
– Reliable: Free from manipulation

Global Equivalents:
– UK: SONIA
– EU: €STR

From LIBOR to SOFR: A Timeline

– 2014: The Federal Reserve forms the Alternative Reference Rates Committee (ARRC).
– 2017: ARRC endorses SOFR.
– 2018: SOFR begins daily publication.
– 2023: USD LIBOR ends; CME Eurodollar futures replaced by SOFR futures.

Forward vs. Backward-Looking Rates

LIBOR was forward-looking, meaning interest payments were known at the start of the period. SOFR is backward-looking, with payments calculated in arrears using compounded daily rates.

Example: Compounded SOFR Calculation

Suppose SOFR rates over a week are:
– Mon: 1.63%
– Tue–Fri: 1.55%
– Fri covers 3 days (weekend)

Using the compounding formula, the effective rate is calculated as:
R = [∏(1 + (di/360) × (ri/100)) – 1] × (360/D) × 100
Resulting in an effective rate of 1.5602%.

CME Three-Month SOFR Futures

These contracts allow market participants to lock in interest rates for a future period.
Specifications:
– Contract Size: $25 per basis point per annum
– Price Basis: IMM Index = 100 – R
– Reference Quarter: 3rd Wednesday of the 3rd month before delivery to 3rd Wednesday of delivery month
– Settlement: Cash-settled based on realized SOFR

Example: May 2025 future

May 2025 SOFR future comes to final settlement on the third Wednesday of August 2025.

The interval of interest rate exposure that informs the contract final settlement price – the contract Reference Quarter — starts on the third Wednesday of May 2025 and ends on the third Wednesday of August 2025. Referenced as May contract even though it settles in August

Sofr futures uses: Hedging a Corporate Loan

A U.S. company borrows $100 million at SOFR for 3 months. Concerned about rising rates, it sells 100 September SOFR futures at 94.50, locking in a rate of 5.5%.
– If SOFR rises to 6%, loan interest = $1.5 million
– Futures profit = 100 × 50 × $25 = $125,000
– Net borrowing cost = $1.375 million → Effective rate = 5.5%

Example 2: Speculating on Rate Declines

An investor expects SOFR to fall from 5.3% to 5.0%. They buy 50 SOFR futures at 94.70.
– If SOFR drops to 5.0%, futures settle at 95.00
– Gain = 50 × 30 × $25 = $37,500

Convexity Bias in SOFR Futures

SOFR futures are linear instruments with a constant DV01 ($25). Swaps, however, are convex, meaning their DV01 changes with rate and time.

Example: Swap vs. Futures Hedge

A 2-year swap with a DV01 of $185.94 is hedged using 7.45 SOFR futures. As rates change:
– Rates fall: Swap DV01 increases → gain > futures loss
– Rates rise: Swap DV01 decreases → loss < futures gain
This mismatch creates a convexity bias, which is priced into SOFR futures.

Conclusion

SOFR futures are indispensable tools in today’s interest rate landscape. Whether you’re a corporate treasurer hedging loan costs, a trader speculating on rate movements, or a risk manager balancing swap exposures, understanding SOFR futures is essential.

Their transparency, liquidity, and alignment with real market transactions make them a powerful instrument for managing short-term interest rate risk.

Eurodollar futures were discontinued in June 2023, successfully transitioning into 3-month SOFR futures. Short Sterling had already migrated into SONIA futures in January 2022.    

Volumes in 3-month SOFR futures are as robust as they were as Eurodollar futures, ranging between 2.5 million and 4.5 million daily with healthy open interest.

So, what are the principal differences between these new RFR futures, and the legacy LIBOR linked futures?

• The most obvious one is the underlying reference rate. SOFR futures reference an overnight rate derived from a broad universe of overnight Treasury repo trade activity, firmly rooted in transaction data from multiple and diverse sources. This overnight rate is essentially a risk-free rate (overnight and secured) and so contains no credit spread like (unsecured) LIBOR did. Consequently, overnight SOFR is almost perfectly correlated with the EFFR. However, 3-month SOFR futures are daily compounded market expectations of a 3-month term SOFR rate which is likely to be very different to the overnight reference rate (in fact, the correlation over a 6-week period is about 0.40 between the two)
• SOFR is an in-arrears rate whereas LIBOR was an in-advance rate. For a term 3-month borrowing or lending, the exact interest amount would be known in advance on a LIBOR transaction, but this amount would only be known in 3 months’ time for a SOFR transaction, since the interest amount would be the daily compounded rate over that 3-month period and so will not be known for sure until all daily SOFR rates in the borrowing period have been published.
• This means the quoting convention for SOFR futures will differ from those of LIBOR futures. Whereas a September Eurodollar future would confer a notional 3-month borrowing or lending from September to December but would expire and settle in September, a September SOFR future will reference a similar period but not settle until December. A September SOFR future will therefore still be live in October and November.     

For example:

• The serial May 2023 SOFR future (K3) comes to final settlement on the third Wednesday of August 2023
• The interval of interest rate exposure that informs the contract final settlement price – the contract Reference Quarter – starts on the third Wednesday of May 2023 and ends on the third Wednesday of August 2023.
• The contract reference quarter for the May 2023 future spans 91 days
  • From and including Wednesday, 17 May (the third Wednesday of May), until (and not including) Wednesday, 16 August (the third Wednesday of August). 
• Referenced as May contract even though it settles in August.
• As a contract approaches maturity, it’s volatility should decline since most of the fixings in the compounded averaging process will already be known (SOFR will accrue as simple interest over weekends and US government securities market holidays and as compound interest otherwise)

What else is different? Well not much…

• Still quoted as 1- futures implied rate
• A basis point is still worth $25 (e.g., the difference between 95.00 and 95.01 in price terms)
• Quarterly contracts more popular than serial contracts
• Convexity bias still applies when trading SOFR futures against Swaps and Treasuries
• All the spreading opportunities that were available using Eurodollar futures still remain, they are just likely to be less volatile, particularly for inter-contract spreads due to the lack of a credit element.

The FCA announced on 5^th March 2021 future cessation of the 35 LIBOR benchmark settings currently published by ICE Benchmark Administration (IBA), which constitutes an index cessation event under the IBOR Fallbacks Supplement and the ISDA 2020 IBOR Fallbacks Protocol. This announcement triggers the official fallback spread calculation published by Bloomberg

The announced end-dates are the same as the ones in the IBA consultations launched in late November.

• Immediately after 31 December 2021, in the case of all sterling, euro, Swiss franc and Japanese yen settings, and the 1-week and 2-month US dollar settings;
• Immediately after 30 June 2023, in the case of the remaining US dollar settings

Short Sterling futures (and Swiss Franc futures) are likely to cease trading post December 2021 with the Eurodollar futures likely to cease trading post June 2023. Euribor futures will continue.  

Any contracts settling after these end-dates will include the official fallback spread.  The Eurodollar M3U3 spread therefore should lock to 26.26bps for 3M USD LIBOR and the Short Sterling Z1H3 spread should be 12.93bps

Eurodollar M3U3 spread

The Eurodollar M3U3 spread closed at 0.24 on 15^th March, a discount of ≈2bps.

Short Sterling Z1H2 spread

The Short Sterling Z1H2 spreadclosed at 0.09 on 15^th March, a discount of ≈4bps.

These discounts reflect potential uncertainty surrounding the FCA announcement that it plans to consult on requiring IBA to continue to publish a synthetic GBP Libor (for a “further period” after end-December 2021). It has also said it will “consider a case” for a synthetic USD Libor to be published for use in tough legacy contracts after end June 2023. This means that there could be a small possibility of these futures continuing beyond the cessation dates.

The eventual discontinuation of Short Sterling, Swiss Franc and Eurodollar futures will mean that there will be no exchange traded derivative product offering a credit element. No more TED spreads or invoice spreads. Eurodollar futures account for about 8% of CME Group revenues with no early indications that SOFR futures will be a viable replacement in terms of volume and open interest.

Risk free interest rates (RFR) like SOFR for USD are replacement rates for Libor. Unlike Libor, RFR do not include a credit spread component and so a spread adjustment is added to the RFR to account for the difference. This spread adjustment is the fallback spread to be used for legacy LIBOR linked contracts when LIBOR publication has been discontinued. There is likely to be different fallback spreads used for cash products and derivatives and ISDA has published their fallback adjustment for derivative markets as follows:

Compounded setting in arrears RFR rate + spread adjustment based on the median spot spread between the IBOR and the term-adjusted RFR calculated over a static lookback period of five years prior to the Index Cessation Event

The index cessation event is a public statement by the LIBOR regulator or administrator that publication has ceased or will cease and result in fallback spreads being fixed and applied as a spread adjustment to the RFR to create an “all-in” fallback rate.

If index cessation event happened today fixing the fallback spread for 3m USD, it would cover a period from December 2015- December 2020 and would be about 26bps (see chart). In contrast, if a cessation were announced in June 2023 then the spread would cover a period from June 2018 to June 2023 and is likely to be lower than 26bps because higher levels of the fallback spread in 2016 drop out of the dataset that the 5Y median references.  

ISDA 3m USD Fallback spread Jun 2015-June 2020.  5Y median = 26bps 

During November 2020, the market was expecting a cessation announcement sometime during 2021 and was pricing fallback spread expectations c. 26bps, to be applied as part of an all-in rate shortly after December 2021. On 30^th November, IBA effectively announced an extension of the discontinuation timeline for US Libor to mid-2023. This caused the market to price expectations that fallback spreads would apply to Eurodollar futures settling post June 2023 based on a spread calculated from a 2021 cessation event.  This caused pre-June 2023 contracts to rally relative to contracts settling post-June 2023 since they would now settle to actual Libor perceived to be lower than the “all-in” rate to be applied post-June 2023. The 4^th December ISDA announcement effectively ratified this pricing adjustment.

For an explainer on Libor transition, see preceding post.

On Monday, 30^th November, IBA announced the start of a consultation that involves an extension of the discontinuation timeline for key tenors in US Libor to mid-. This announcement caused ED futures settling pre-June 2023 to move higher since expectations are that these contracts will now reference actual Libor, expected to be lower than fallback Libor that would affect contracts settling post-June 2023. 

EDM2 reacts to IBA announcement on 30^th November. Chart by Refinitiv

On Friday 4^th December, ISDA stated, “an announcement early next year for all US dollar LIBOR tenors would fix the spread for all tenors. And in that instance, the spread would be applied – that is to say, contracts would fall back to the fall-back rate after June 2023.”

ED futures continued their post 30th November trend more aggressively by re-pricing the post-June 2023 strip (referencing the fall-back rate) about 10bps higher (futures price fall 10 ticks) than those settling pre-June 2023 (which would continue to reference USD 3m LIBOR).  ED M3U3 widened by about 10 ticks from 30^th November. This was effectively a 10 standard deviation event on a one-year trading range of 4.5 ticks.  

ED M3U3 spread widens 10 ticks on elevated volume. Chart by Refinitiv

Benchmark reform is the impending  transition from one type of interest rate used to reference some $350 trillion of corporate loans, debt and derivative product from the end of 2021-mid 2023 to other alternative rates. It is likely to affect interest payments and product valuation.

The most popular benchmark reference interest rate is the London Interbank Offered Rate (LIBOR. It is supposed to be representative of wholesale, unsecured transactions in a variety of hard currencies (presently USD, GBP, EUR, GHF and JPY) for several maturities between overnight and 12 months. Every business day, a benchmark administrator collates submissions from contributor banks based on their actual transactions or by using the contributor’s expert judgment when few or no transactions have taken place, and publishes LIBOR fixings. Global lending markets reference these fixings for customer and client borrowings, usually adding a credit spread to reflect the relative creditworthiness between borrower and lender. These fixings are also an integral component for huge amounts of derivative and capital markets product. 

The early 2000’s saw advances in credit risk management practices that made bankers increasingly reluctant to lend wholesale funds on an unsecured basis on anything but an overnight term – the premise being that fewer bad things might happen to monies lent overnight compared to a term loan. Consequently, most of the approximately $500m daily LIBOR transactions are overnight only meaning that term LIBOR fixings are largely subjective, not being based on any substantial amount of trade.  In the past, this has made term LIBOR susceptible to manipulation, resulting in fines for banks and prison sentences for traders. The early response was the Wheatley Review in 2012, initial reform of LIBOR, greater regulatory oversight and a recommendation by the Financial Stability Board in July 2014 to develop nearly Risk Free Rates (RFR) as alternatives to LIBOR. This is benchmark reform.

Working Groups on alternative reference rates in various jurisdictions have proposed different risk free rates to replace LIBOR; some using secured financing data sources whilst others reference unsecured money market data. They have varying publication times, different administrators and all are overnight rates only.

In the United States, the Secured Overnight Financing Rate (SOFR) is the preferred risk-free rate for USD markets. SOFR derives from secured financing transactions, otherwise known as repo. Over $1trillion of SOFR linked transactions transact each day. Repo markets have their own challenges though, demonstrated by recent ructions in US markets due to liquidity issues. Perversely, this can result in a replacement risk free benchmark rate that is potentially more volatile than the rate it is replacing.

Term LIBOR fixings give cash flow certainty. A borrower borrowing money today for 12 months will know exactly how much they will have to repay in a year’s time if the loan references a 12-month LIBOR rate fixed today.  This is an in advance borrowing. Replace this with an alternative rate referencing an overnight rate instead and the borrower will have to wait until the loan matures before they know exactly how much is due. This is an in arrears borrowing. The lack of a term structure for many proposed replacement rates creates uncertainty of future cash flows.

Additionally, most borrowers, lenders and derivative markets participants will have legal documentation detailing their obligations.  Within these documents is fallback language that sets out the legal steps to be taken in case LIBOR becomes temporarily unavailable. These contracts will need amending for a permanent discontinuation, involving a trigger protocol, details of the replacement rate and a replacement spread applied to the new rate to make it economically equivalent to the old rate, replicating existing credit spreads with no financial advantage or disadvantage to borrower, lender or derivative counterparty.

Benchmark reform in various jurisdictions is currently at different stages of transition, and is moving at different speeds towards, in all likelihood, different outcomes. The results could potentially have an unpredictable and adverse impact on the valuation and obligations of financial instruments like loans, bonds and derivative product. Financial organisations will need to adapt to new or amended operational processes and changes to contractual documentation will require communication, education and treating customers and clients fairly.

A strip of Euribor futures are derivatives on sequential forward starting inter-bank offered rates. As would be expected, each Euribor future is highly and consistently correlated with its adjacent contracts.  For example, a Z0 future (expiring in December 2020) might be ≈98% correlated with the H1 (March 2021) contract.  

This stable relationship between adjacent contracts make spread trading in the form of calendar spreads (future1 -future2) or butterfly’s (future1- 2x future2-future3) very popular as a low volatility trading strategy albeit often requiring high leverage in order to generate enough return.

It is difficult to imagine how Euribor futures could ever become negatively correlated to each other but as is often with risk, reality can be stranger than theory. This happened once in my trading lifetime in 1999 due to a phenomenon subsequently called the millennium fly. This was when the Z0 (December 2000) futures sold off sharply (implied forward rates increased since stir futures are quoted on a 100-r basis) whilst the adjacent U9 (Sept 1999) and H1 (March 2001) contracts continued a upward trend (implied forward rates decreased) in line with other interest rate related product. This effect was later attributed to a US bank allegedly being refused access to funding markets in the new millennium for being deemed to be non-Y2K compliant.  

This effect of Euribor futures becoming negatively correlated has happened again for the first time in 20 years (to my knowledge). During the 2019, up until 24^th July, the Z0H1 (December 2020-March 2021) spread traded in a range of 0.02 to 0.07 with an average daily spread volume of ≈4000.

During normal trading hours on 24^th July, the Z0H1 spread had traded between 0.02 and 0.03, but from 17:25 hrs to 17:37 hrs on the same day, blew out to 0.14 and then traded back down to 0.03 by 18:37pm on a volume of over 90,000 contracts. This was driven by aggressive buying of ≈60,000 Z0 contracts from a price of 100.565 to 100.640 whilst the H0 sold off from 100.535 to 100.510 on volume of ≈28,000 during the same time period (17:25 hrs to 17:37 hrs).

The charts below graphically display the moves in the both the spread and the individual futures contracts, highlighting the temporary enforced negative correlation between Z0 and H1. Charts by Reuters Eikon.

This was probably a very expensive 12 minutes from the perspective of proprietary traders and the instigator of the trade. The adverse mark-to-market on leveraged short Z0H1 positions might have led to proprietary traders buying back short spreads to reduce inventory but thereby exacerbating the move. Whoever or whatever was behind the trade would have ultimately lost money since the spread and the individual component futures contracts subsequently normalised back to levels seen earlier in the day. Given that none of the trades violated the Exchange’s tolerances and circuit breakers, all trades stood, and none were cancelled.

The move defies logic. The next day (25^th) was an ECB policy meeting day but rates were unchanged and there was no market moving news regarding QE policy. The move was measured in minutes, not milli-seconds, perhaps ruling out a fat finger or flash crash. Someone might have a very specific idea regarding European rates in Q120, but it was awful trade execution to achieve it. Market manipulation? Isn’t the idea the make money from that. This trade would have lost the instigator money. Focus will probably fall on an algorithmic error, but the reality is that we will probably never know for sure.  Maybe it’s a sign of age but when things like this happen, I’m glad that I’m no longer in the game!  

Stir futures are, of course, futures on short term interest rates, primarily IBORs (interbank offered rates). The Eurodollar and Short Sterling are based on LIBOR (London Interbank Offered Rate) and the Euribor is named after its underlying reference rate – EURIBOR (Euro Interbank Offered Rate).

Because of the LIBOR/EUROBOR fixing scandals, plus operational aspects like the lack of volume and submission and fixing methodology, the FSB (Financial Stability Board) published a report in 2014 on “Reforming Major Interest Rate Benchmarks” which provided the basis for the FCA’s (Financial Conduct Authority) decision to sustain LIBOR until the end of 2021. After that, panel banks will no longer be required to submit LIBOR rates, which likely lead to the demise of LIBOR as a reference rate and remove the demand for derivatives based upon it.

As an alternative, the following have been adopted as reference rates

USD: Secured Overnight Financing Rate (SOFR)

EUR: Euro Short-term Rate (ESTER)

JPY: Tokyo Overnight Average Rate (TONAR)

GBP: Sterling Overnight Index Average (SONIA)

CHF: Swiss Average Rate Overnight (SARON)

SOFR is a fully transaction-based reference rate, derived from a composition of repo rates – General Tri-Party (Bank of New York Mellon), DTCC cleared General Collateral and Bilateral FICC cleared. SOFR daily trading volume is around $800 B which is about 1500 times the daily LIBOR transaction volume.

In the US, SOFR futures were introduced by CME in May 2018 and because they are based on a secured financing rate (in contrast to LIBOR being based on unsecured financing), the SOFR futures trade at a higher price (lower rate) that Eurodollar futures.

Source: Bloomberg

Volumes are increasing

Source: Bloomberg

And a developing market in inter contract spreads

Source: Bloomberg

Based on a presentation by Numerix

Are changes in Euribor fixings correlated with movements in the Euribor implied forward rates?

Intuitively, we might think so but empirical evidence suggests otherwise. Given a data set from January 1999 to May 2017, there were 2740 days when a change in the Euribor fixing was replicated with a similar movement in the implied forward rates of the white pack and 1964 days when they were not. This results in a low correlation of just 17.6%. Breaking the data into smaller 5-6 year buckets does not demonstrate causality between the direction of Euribor fixings and movements in the Euribor futures implied forward curve.