The U.S. Federal Reserve and Eurodollar Contracts

We all would like to know the upcoming things in crypto and financial market.
Maybe the U.S. Federal Reserve and debt are major factors to change investors’ future.

Eurodollar

Eurodollars is one of the most opaque and yet insanely massive part of the financial system. It’s the less regulated version of the U.S. dollar that resides in Europe.

For the perspective in how important they are, the December 2022 Eurodollar contracts have 1.5 million contracts of open interest.

Each contract is $1 million in size. Which means for one contract we are talking trillions of dollars of interest. That’s a lot.

In terms of why these contracts are even traded in the first place, I’ll use Chicago Mercantile Group’s explanation, “Eurodollar futures and options are the preferred tool of traders to express views on future interest rate moves”.

Summed up, Eurodollar futures are an expectation for what interest rates will be at the time of their expiration.

If you think rates in some year down the line will go up or down for whatever reason, then you can use these contracts to profit.

Now, the interest rate in question that Eurodollars track is actually the LIBOR rate.
All you need to know is LIBOR is another type of borrowing rate created between banks.
And this rate tends to be about 10-15bps greater than the Fed Funds rate.
But to keep the essay simple and convenient It may be good to refer to Eurodollar futures as the FED’s expected rate at the time of expiry.

Said another way, for our purposes here I will use Eurodollar futures as a proxy for future expectation of FED rates.

For a quick example on how we can interpret what the price of contract means, right now the December 2022 contract is 96.195. If we take 100 and subtract 96.195 from it, we get 3.805. Which tells us in December the market thinks rates will be at 3.8%, higher than where we are today.

The FED has been aggressive about raising rate for a couple months now.
So the question comes up whether or not the market has priced in these expected hikes or not.
And in terms of crypto, when these rate hikes become less aggressive, expect capital to get deployed into the industry.

The History

To figure out how to interpret how direction matters let’s look back at at a time when rates(bottom white line) were near zero, Eurodollars were converging, and the then FED was increasing rates.
It’s a situation similar to what we are facing today.

Just like markets expand and contract, so do Eurodollar futures curves.

In the chart above, notice how the multi-color lines around get spread out as the white line at the bottom (labeled as Fed Fund rates) approaches zero.

I think of this as the start of a new cycle. A time period after stocks crashed and the FED is now returning back to zero rates. A reset.
This transition back to the floor where interest rates are near zero and market prices are low is the FED restarting the economy after a blow.
So again, rates hit the floor. while the multi-color lines that represent Eurodollars futures contracts expand.
Rates at zero, Eurodollars expanding.