CME Group has developed a tool to help clients visualize the potential impacts of European Central Bank (ECB) monetary policy decisions on the expected prices of €STR futures. By allowing users to input their own expectations of what the ECB might do in upcoming meetings, this tool provides a view of where CME Group €STR futures (Globex code: ESR) prices could settle if the user’s expectations prevail.

To comprehend how the tool transforms monetary policy expectations into potential settlement prices for €STR futures contracts, one must first understand the benchmark rates involved in these calculations, as well as a few assumptions the tool makes.

The ECB is responsible for setting the benchmark policy rates for the euro area, and it does so during a number of meetings that take place throughout the year. At each of these meetings, the ECB decides whether to maintain, hike or cut a range of policy rates. Typically, these moves take place in 25 basis point (bp) increments (0.25%), and three rates are determined at each meeting: the interest rate on the main refinancing operations by the ECB, as well as the interest rates for the marginal lending facility and the deposit facility. Out of these three, the €STR rate most closely tracks the rate on the ECB’s deposit facility.

Given the high correlation between these policy rates and overnight €STR rate, both tend to move together, with hikes and cuts being matched in the €STR rate as soon as the next business day following a monetary policy decision. Despite being very well correlated, there remains a slight basis (or spread) between the ECB’s rate on their deposit facility and where the €STR rate prints every morning.

One key assumption that this tool makes is that the basis (or spread) between the ECB policy rate and €STR is held constant for the purpose of calculating projected forward €STR rates. That is, the tool observes the current policy rate and compares it to the most recently released €STR – the difference between both is established as a fixed constant which is then used to estimate potential future €STR fixings.

Once a projected €STR benchmark curve has been established, one can aggregate the relevant rates to calculate what the projected final settlement prices of any Three-Month €STR futures (Globex code: ESR) contract might be. For more information about the methodology used to calculate the final settlement of CME Group €STR futures contracts, please refer to the European Overnight Index futures final settlement calculation whitepaper.

How the tool works

The €STRWatch tool has a couple sources of data: benchmark policy rates and ECB meeting data is acquired via the ECB, while €STR futures reference period dates are supplied through CME Group internal systems.

The first thing the tool does is establish a fixed spread between the latest €STR rate and the current ECB policy rate. This value is saved for use in all subsequent calculations.

The tool presents users with all scheduled ECB monetary policy meeting dates alongside the applicable dates when any rate changes go into effect (also known as the start of the reserve maintenance period). The user is given the option to input their own expectations of rate changes at each of these upcoming meetings by typing in the size and direction of the change (-25 for a 25 bp cut and +25 for a 25 bp hike, for example). Although the policy rate typically moves in multiples of 25 bp, the tool permits inputs of any size, such as +60 for a 60 bp hike, for example.

Finally, given the user’s monetary policy expectations, the established spread between €STR and the target policy rate, and the past €STR fixings, the tool can imply where €STR futures prices might settle.

For each date in the future, the tool looks at the target policy rate and applies any user-inputted cuts or hikes that would have been effective by that date, as well as the established fixed spread between the policy rates and €STR. The resulting figure is saved as the implied €STR fixing for that date.

For example, if the current policy rate is 5.00%, the fixed spread between that rate and €STR was established by the tool to be -10 bp, and the user has inputted his expectations for a 25 bp cut in the upcoming ECB meeting, then the tool would imply an €STR fixing for the dates after the start of the relevant maintenance period equal to: 5.00% - 0.10% - 0.25% = 4.65%. This would be the implied €STR rate for all days until the subsequent user-defined change in the policy rate.

Repeating this for all relevant dates into the future, the tool creates a continuously compounded €STR value for each day, compounding the daily €STR fixings from the first relevant contract date until the last implied future €STR fixing calculated. This allows the tool to price any Three-Month €STR futures contract by simply dividing the continuously compounded €STR value for the last day in the contract’s reference period by the value for the first day in the period.

Effectively, this process derives the implied three-month compounded €STR rate which is used to calculate the final settlement price for CME Group Three-Month €STR futures contracts.

In the case of a contract whose reference period has already begun, the tool utilizes a mix of actual and implied €STR fixings to calculate a potential final settlement price.

Outputs

Having performed all of the calculations described above, the tool displays the following outputs:

  • One table displaying the current prices and implied final settlement prices for each €STR futures contract expiry, as well as the difference between both
  • A chart of past and implied future overnight €STR fixings
  • A chart of the current and implied term structures for Three-Month €STR futures contracts, as well as the difference between both for each of the contract expiries

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.

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