With this year's Jackson Hole summit behind us, market sentiment on rate cuts is very strong. Federal Reserve Chairman Jerome Powell gave direct signals that the central bank’s multi-year battle with inflation may be coming to a close.
Investor expectations are high for a September rate cut after Federal Reserve Chair Jerome Powell signaled at the recent Jackson Hole summit of central bankers that the “time has come” for a change in monetary policy following the steady decline in inflation and a softening of labor market conditions while economic growth is stable albeit slowing.
The Fed hiked interest rates to their highest levels in about two decades at 5.25% – 5.50% to beat back inflation that topped 9% at its peak caused by a combination of supply chain disruptions and a shift in consumer demand while sequestered during the pandemic. Any move now by the Fed to cut rates could have ramifications across markets.
As of September 9, 2024, CME FedWatch is pricing in a ~75% chance of a 25 basis-point cut and a ~25% of a 50 basis-point cut for the September 2024 FOMC meeting. Those looking to mitigate their short-term interest rate risk might consider locking in their short-term rate exposure.
Money market funds are mutual funds that invest in short-term, low-risk financial instruments. The returns of money market funds are determined by the income generated from the fund’s investment. These investments typically include Treasury securities, commercial paper, certificates of deposits and reverse repo. The interest rates on these investments are dependent on market conditions, and the fund’s overall return is closely tied to the yield of these underlying assets, which reflects the income earned from them. The primary goal of these funds is to provide investors with a safe place for capital preservation while simultaneously providing a moderate return.
Money market funds hold a substantial amount of T-Bills, and many of the largest money market funds refer to the 3-month T-Bill as their benchmark rate. The 3-month T-bill represents the return on a virtually risk-free investment with a similar exposure to the assets held by money market funds. It is an indicator of prevailing short-term interest rates, highly liquid, and widely followed. Money market funds are keenly watching interest rate movements as lower rates evoke uncertainty when rolling over cash positions, thus risk managing their T-bill exposure is essential.
CME Group launched 13-Week Treasury Bill futures (TBF3) in October 2023. Since then, the product has seen success, surpassing 13,000 contracts in open interest (OI) in early September 2024. T-Bill futures settle to the 13-Week Treasury Bill highest-accepted discount rate, published by the U.S. Department of the Treasury. T-Bills are short-term debt securities and are backed by the full faith and credit of the U.S. government. The principal advantages of T-Bills are their stability and safety, as they are free of credit risk. For more on T-Bill futures, visit Understanding 13-Week Treasury Bill futures.
Exhibit 1 - Treasury securities in money market funds (January 2023 to January 2024
In Q1 2024, money market funds held about $2.6 trillion of Treasury securities, $2.1 trillion of which were T-Bills. Many of the largest money market funds are composed of about 30% U.S. Treasury bills.
T-Bill futures are specifically designed to track the performance of short-term U.S. Treasury bills. Since money market funds invest heavily in these government securities and use the 3-month T-bill as their benchmark, T-Bill futures provide a more direct hedge against interest rate fluctuations affecting these assets than other short-term interest rate futures from a basis perspective.
Although money market funds are associated with low volatility and risk, it is crucial to understand that they are not risk free. T-Bills are susceptible to interest rate risk, and their prices can change if the overall interest rate environment changes. With interest rate cuts on the horizon, currently issued T-Bills may trade higher. Money market investors should be mindful of how market conditions may impact their holdings.
T-Bill prices are inversely correlated with interest rates. When the Fed lowers rates, the yield on newly issued T-Bills will decrease since their returns are closely aligned with target rates. Existing T-bills, in comparison, will become more attractive due to their higher yields, potentially leading to an increase in their price. Money market funds holding T-Bills may see a decrease in the returns they can offer their investors. With a high proportion of T-Bills in money market funds, performance is closely tied to prevailing short-term interest rates.
Institutions with capital stored in money market funds can look to T-Bill futures to hedge their short-term interest rate risk. Consider the scenario where an investor is looking to lock in their short-term interest rate exposure to protect their money market fund investments. On August 23, 2024, the investor entered a long position in December 2024 T-Bill futures at 95.835, implying a 4.165% discount rate for the 13-week T-Bill auction on December 16, 2024
Exhibit 2 - T-Bill futures Settlement Prices (July 26, 2024, August 9, 2024, and August 23, 2024)
Assume a scenario where the Fed cuts rates aggressively and the target Federal Funds rate sits at 400 – 425 basis points by the time of the December 2024 TBF3 final settlement. Since T-Bill yields are closely aligned with interest rates, the discount rate for the 13-Week T-Bill auction in December will likely be in this range. Suppose that this discount rate for this auction is 4.125, implying a T-Bill futures price of 95.875 for the December 2024 contract.
The price of the futures contract went up four basis-points. With a dollar value of one basis-point change (DV01) of $25, the value of the position went up $100 per contract traded. The trader was effectively able to “lock in” a higher rate exposure, and protect themselves from the fall in short-term treasury yields.
As demonstrated, 13-Week U.S. Treasury Bill futures are an effective hedge for interest rate risk. With more favorable inflation reports and weakening job data, the market is primed for a pivot in monetary policy, favoring rate cuts. With the transparent and highly liquid marketplace at CME Group, standardized T-Bill futures contracts offer investors a value tool to mitigate their short-term interest rate risk.
Contract Specifications
| Contract unit | $2,500 X Contract-grade IMM Index |
| Price quotation | Contract-grade IMM Index = 100 minus R R = highest accepted discount rate on the 13-Week T-bill auction Example: Contract price of 97.2800 IMM Index points signifies contract rate, R, of 2.7200 percent per annum. |
| Trading hours | CME Globex: Sunday – Friday 5:00 p.m. – 4:00 p.m. CT with a 60-minute break each day beginning at 4:00 p.m. CT CME ClearPort: Sunday 5:00 p.m. – Friday 5:45 p.m. CT with no reporting Monday – Thursday from 5:45 p.m. – 6:00 p.m. CT |
| Minimum price increment | Any contract with one month or less until the last trading day: 0.0025 IMM Index points (¼ basis-point per annum) equal to $6.25 per contract. All other contracts: 0.005 IMM Index points (½ basis-point per annum) equal to $12.50 per contract |
| Commodity code | TBF3 |
| Listed contract | Four quarterly (Mar, Jun, Sep, Dec) contracts set to expire on the Monday preceding the third Wednesday Two serial contracts set to expire on the Monday preceding the third Wednesday of serial months (Jan, Feb, Apr, May, Jul, Aug, Oct, Nov) |
| Settlement method | Financially settled |
| Termination of trading | Last trading day: Monday prior to the third Wednesday (IMM Wednesday) (or Tuesday if Monday is not a business day) of the contract month Termination of trading time: 2:00 p.m. CT on the Last trading day |
| CME Globex algorithm | Allocation (A Algorithm, with top order allocation = 100% and pro rata allocation = 100%) |
| Block trade minimum | 100 contracts |
All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.
