Quarter-End Fed Funds vs SOFR Trade

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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