Despite a less-than-stellar launch, some traders expect the Chicago Mercantile Exchange's federal funds rate futures and options contract to be a popular vehicle for speculation should the Federal Reserve raise interest rates later this year.
Rich Baum, vice president of Eurodollar operations with Rand Financial Services Inc., attributed the contract's lackluster start to the Federal Reserve's satisfaction with the current interest rate environment.
As a result, he said, the usual short-term interest rate customers are staying on the sidelines.
However, Mr. Baum said, market observers expect short-term rates to rise 25 to 50 basis points before the end of the year, a factor that could give the new contract a spark.
"There's a lot of optimism that this fed funds contract will be a tremendous success," he said. "It's just sort of lost in the shadow of a lot of other things going on."
In its first day of trading, the futures contract, which is offered in direct competition to a similar contract at the Chicago Board of Trade, exceeded sales volume of 800 contracts. At $3 million face value per contract, that amounts to $2.4 billion worth of contracts changing hands.
The volume was nearly evenly split between the November, December, and January settlement months, said Peter Barker, director of currency and interest rate marketing at the Mercantile Exchange. The contracts have monthly settlement dates extending one year in advance.
Mr. Barker said the new fed funds contracts give derivatives desks at commercial banks a short-term, domestic interest rate contract to use for hedging. He said he expects the contracts will be useful in allowing traders in repurchase agreements to lock in their funding rates.
"These contracts track the repo market pretty well," he said.
Likewise, he said the contracts are another tool for traders who wish to trade on the relationships between different interest rate markets. Besides the fed funds contract and Treasury bills, the exchange also offers short- term interest rate contracts based on the London Interbank Offering Rate, or Libor, and Eurodollars.
The exchange also announced on Oct. 17 that it will add two settlement dates to its series of Eurodollar futures contracts. In the first nine months of this year, the contracts generated trading volume in excess of 86.2 million contracts.
In fact, it is the Mercantile Exchange's complement of short-term interest rate contracts that gives the exchange a cost advantage over its crosstown rival, Mr. Baum said.
He pointed out that short-term interest rate traders can take a position on the Mercantile Exchange's fed funds contract and eliminate the need for cross-margining on the two exchanges.