While interest rate corridors remains an insightful and important topic to currency prices, markets and monetary policy, to delve further into corridors on a per nation basis offers a far more comprehensive perspective.
Daily Interest rates in AUD, NZD, USD and GBP are not only low but statistically flat on the floor low. Statistically flat means interest rates contain problems in range, location and direction as the view inside current prices reveals a lost and wandering rate in dire need of input to force a meaningful direction.
GBP is most interesting because despite low, the BOE can actually maintain interest rates at current levels into the future. A drop brings interest rates to the lowest depths of lows to match AUD, NZD and USD. Yet a drop must be questioned to the effects on AUD and NZD as interest rates throughout nations are cemented tighter than glue. AUD and NZD interest rates lack ability to go lower.
The current debate inside the BOE to raise, lower or maintain will continue as the BOE must question severely oversold interest rates from monthly averages 1 to 10 years to daily low yet acceptable trading levels.
Fed Funds is severely overbought from a monthly average view 1 to 12 years yet the daily interest rate trade levels are extremely low. The reconciliation is to view levels and averages to ranges. The 10 to 2 year and 10 to 3 month averages are both the same at 1.76 to 1.78.
The spreads are both at 0.87. The spread factors as the current range and the overall range is 0.89 and 0.91 to 2.63 and 2.65. Topside levels bump against the 2.51 average at the 10 to 30 yields. The spread is 0.59 therefore the current range is 1.92 to 3.1. Then the 10 to 5 averages at 2.00 to 2.03 against a 0.42 range means 1.58 and 1.61 Vs 2.42 and 2.45. Ask is the Yield curve negative from 1.76, 2.00 and 2.51 or are ranges to low and problems from 0.89, 0.42 and 0.59.
Actual statistical ranges from 1.76 at 10 Vs 2 and 10 V 3 months equates to 1.43 to 2.08 or 65 points total and 33 below vs 23 points above. The actual 65 point range is far lower by 24 points than the current 89 point spread.
The 10 to 5 spread at 0.42 is actual 1.83 to 2.17 or 34 points total, 17 points above and 17 below from the 2.00 average. The 10 to 30 average at 2.51 and 0.59 spread factors to an actual range from 2.27 to 2.75. The actual range is 48 points or 24 points below vs 24 above.
Interest Corridors are maintained by trading daily interest rates at the extreme low end to protect bottoms, to maintain orderly function in respective markets but most importantly to offer an invitation at acceptable levels to trade a nation’s interest rates. The low end and invitation under new central bank policy tools sacrificed exchange rate movements to drive trading to interest rate markets as volume, liquidity and business in interest rate markets are far more larger than exchange rate markets.
Interest rates are now the new exchange rates and a domination in the market. A fierce competition developed and now exists against each nation’s overnight rates and this is the manner how interest rates became tightly bound together. Nations won’t allow an advantage over the next nation as a move in one nation’s interest rate is met automatically by an interest rate move in all nations.
Previously, interest rate corridors were wide enough to allow a harmonious existence between interest and exchange rates where the exchange rate even became preeminent. The methodology and practice shifted to interest rate corridors as the pre eminent mode to control exchange rates and levels. More importantly, interest rate markets are now professionalized to only the knowledgeable and possibly as a payoff to banks, corporations and money market funds but at the expense of exchange rate traders. Only the professional have access to true interest rate prices.
Exchange rates were far to volatile for this cohort as trade management became more than a full time job to include forecasting, hedges and the point of profit and loss to operations. Proctor and Gamble trades on any given day hundreds of currency pairs. Its far easier for Proctor and Gamble to trade an interest rate as 2 to 4 decimals places rather than 6 decimal places in exchange rates.
Exchange rates in the 1990’s moved 400 and 500 pips per day under wide corridors while today’s exchange rate markets experience barely 100 pip days on good trading days. EUR introduction experienced focus and institutionalization on overnight rates then Overnight Indexed Swaps were introduced to begin the focus on interest rates and away from exchange rates. Interest rate maturities began a slow rearrangement and elimination of certain maturities.. In 2015, the new interest rate program was introduced by central banks to solidify the narrow corridor. The final result is today’s complete focus on interest rates, away from exchange rates and narrow interest rate corridors.
Consider today’s typical 15 point interest rate channel. An interest rate trader only needs a few points to nicely profit. A 15 point channel for an exchange rate trader is extremely tiny and results in small movements. Fed Funds trades easily $100 billion per day while DX Futures on ICE traded 17,000 contracts or roughly $85,000. Australia’s OCR traded in USD millions 3423 Friday on a light volume day while AUD/USD traded barely 150 Futures contracts.
Why the channels is because interest rate traders want rate stability and non movements in borrow and lend rates in order to hold positions and manage money for years. While bottoms are known, upper channel rates are known far in advance as well.
Interest rate swaps for exchange rate purpose includes OIS, Forward interest rates, Basis and Fixed V Float. Fixed Vs Float is argued as essentially the same as OIS for illustrative purposes.
The CFTC’s Weekly Swap Report released every Wednesday states Gross Total Notional Interest Rate Swaps Outstanding in USD and in millions amounts to 236,388, 714 and as cleared trades includes 152, 545, 368 and 83,843, 347 uncleared. Interest rate markets are extremely active for current participants.
The Fixed -Float accounts for USD total 112, 661, 812, Forwards 32,281, 129 and OIS 32, 464, 172.
The Fixed Float by Currency factors to USD 40,930,622, EUR 29,777,558,
GBP 7,182,562, JPY 8,722,091 and AUD 6,026,353.
Forward Interest Rates in USD 15,177,674, EUR 10,651,966, GBP 3,156,768, JPY 1,762 and AUD 1,198.
OIS in USD 11,488,263, EUR 10,953,068, GBP 3,242,478, JPY 275,932 and AUD 4,409,385.
Narrow interest rate corridors is seen in length of time in Swap trades starting from 0 to 3 months in Fixed V Float. Note how trades increase in time and duration.
Fixed V Float 0 to 3 months 1,525,083, 3 to 6 months 2,814,149, 6 to 12 months 9,422,743, 12 to 24 months 14,257,903, 24 to 60 months 23,821,183, and 60 + months 60,820,751.
Forward Interest rates 0 to 3 months 5,257,464, 3 to 6 months 7,587,996, 6 to 12 months 13,652,164, 12 to 24 months 5,229,999, 24 to 60 months 552,043 and 60+ 1,462.
OIS from 0 to 3 months 4,128,362, 3 to 6 months 8,051,810, 6 to 12 months 10,851,528, 12 to 24 months 5,355,161, 24 to 60 months 2,137,128 and 60 + 1,940,183.
For OIS perspective and context to weekly views, June 2011 OIS contracts outstanding totaled $3.6 trillion and turnover in the year to June 2011 was $6.6 trillion.
Overnight rates remain fixed in tiny ranges from day to day purposefully to allow the OIS connection to 90 day rates and to establish parties in a Fixed for Floating rate trade. One side borrows while another lends. One side receives payments while the other side pays.
In an OIS Swap, fixed interest payments are swapped vs a variable interest payment. The floating or variable interest is connected to the overnight rate hence again why its in the interest of the swap market for overnight rates to remain steady.
OIS is most important to interest rate views and vital to currency markets because its a short rate / short term financial instrument. OIS as well assists predictions in central bank interest rate rises and falls. Short rates drive markets and prices. Standard Interest Rate Swaps contain far longer durations and lacks the predictive powers and insights of OIS.
Traditional OIS informs immediately to market problems as an early warning because OIS rates rise. Yet low OIS rates informs healthy market functions. Trump, North Korea and possible war should’ve seen OIS rates skyrocket but OIS rates remain low and stuck inside its narrow corridors because of the large monies tied to its current rates.
Large amounts of the world’s money is channeled into narrow interest rate channels against the same old non move able daily interest rates. This system doesn’t allow nor does a need exist to move interest rates.
Exchange rate movements suffer in OIS and Swap arrangements. Interest rate curve averages on any given day barely move 1 to 2 points to offer a non movement example. The risk is OIS rates jump higher due to crash, war or catastrophe and the vast amounts of money tied to OIS is lost as all the eggs remain in one basket.
GBP OIS rates Friday were 0.066, USD 0.155, AUD 0.19 and 0.33 for NZD. One aspect to GBP is OIS rates are not a target price for the BOE. AUD, USD and NZD is quite a different story as those rates maintain a high significance. However NZD remains the currency never to worry because the system, operation and function of RBNZ interest rates is smart, well thought and functions extremely well. The RBNZ is always prepared because they build protections against any world action. Remarkable brilliance in the RBNZ.
OIS rates are ready to finally move and the move contains potential to become significant as current rates in relation to its channels sit at polar opposite extremes. Due to narrow channels however, OIS could trade to a higher range and reach destinations slowly.
Brian Twomey