LIBOR Was Expected To Drop. It Dropped. What Might This Mean?

Everyone hates LIBOR until it does something interesting. It used to be the most boring interest rate in the world. When it was that, it was also the most important. Though it followed along federal funds this was only because of the arb between onshore (NYC) and offshore (mainly London, sometimes Caymans) conducted by banks between themselves and their subs (whichever was located where). Unsecured markets used to be central.

Today, LIBOR dropped sharply. People are talking about it. A few have thoughts. This is supposedly highly irregular and unexpected, except that it was expected by everyone. Everyone who trades in eurodollar futures and (honestly) observes that market’s movements.

Here’s what I wrote on December 28:

The current front month is January 2019, and its quoted price as I write this is 97.2475. The EDH (March) 2019 contract trades at 97.29 currently and it will drop off the board on March 18.

Three-month LIBOR was fixed yesterday at a fraction higher than 2.80%, meaning that if it stays around or above that level someone is losing money on it. The futures price isn’t directly translatable but back-of-the-envelope it works out to an expectation for 3-month LIBOR on that date in March to be less than what it is fixed now.

In other words, the market is seriously betting LIBOR is coming down not two years from now but in the short run. That expectation only grows the further out in time (down the curve).

The eurodollar futures market has said for weeks, months since inversion, that balance of probabilities 3-month LIBOR was going to start to decline. It has started to decline.

When all this rough stuff began at the beginning of December, around Dec. 4, the February 2019 contract, the current front month with January’s maturity obviously now off the board, was priced at 97.165; ~2.83% for 3-month LIBOR. That was a bit higher than where the London money rate was at the time.

By the time we got through all the chaos to January 3, the price had skyrocketed up to 97.31, or market expectations for 3-month LIBOR around 2.70% or so in February. That meant the eurodollar futures market at the outset of 2019 was betting (in the trillions) that LIBOR was going to drop by at least 10 bps if not more.

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Disclosure: This material has been distributed for informational purposes only. It is the opinion of the author and should not be considered as investment advice or a recommendation of any ...

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