Interest rate decisions made at meetings of the Federal Open Market Committee (FOMC) are typically market-moving events as they help define the Federal Reserve’s monetary policy stance. While instruments like the CME FedWatch tool can fairly accurately project expectations of whether the FOMC will raise rates or not at those meetings, the actual announcement usually drives increased volume in key treasury products. Additionally, the press conference by the Fed Chair following the announcement provides insights into the Fed’s opinions on the state of the economy, its perception of inflation and to some extent its interest-rate path, frequently leading to additional market activity. On September 26, 2018, the FOMC made a scheduled announcement that it would increase core interest rates 25 basis points, to a range of 2% - 2.25%. The decision was announced at 1 pm CST, and the market’s reaction was clearly visible in the hourly data shown below.
There is a perception that such market activity and subsequent volatility caused by such events can reduce market liquidity, thereby limiting the ability of traders to execute in a timely fashion in response to the event. The analysis below examines this and concludes that some measures of volatility did increase in response to the FOMC’s announcement. However, the volatility corresponded with a widely consistent level of market depth at the top-of-book. Additionally, the replenishment rate of the book was strong throughout the day, meaning that even as depth was absorbed by executed trades, frequent replenishment of orders allowed traders to execute without undue restraint due to market dynamics. Finally, implementation costs at various lot sizes remained largely unchanged in the wake of the FOMC’s announcement, ensuring participants could trade and manage their risk within the normal cost range.
The 10-year Treasury Note is a benchmark contract for traders, reflecting changing market dynamics and sentiments. The Ultra 10-year Treasury Note is a derivative that has seen growing interest from market participants looking to more precisely manage their interest rate risk. Additionally, the Treasury Bond illustrates the market’s expectations for long-term changes to fundamentals.
As the FOMC announcement was made at 13:00, traders moved quickly to respond to the increased rates and drove volumes significantly higher in the hours after the announcement. All three products topped their average hourly volume for the previous month. Specifically, in the hours between the announcement and the close of Chicago markets (13:00 – 16:00 hours), the three products traded more than 190% more than the average for the same hours in the rest of September.
The maximum and minimum prices during each hour reflect a similar pattern as seen in volume, with the most significant movement coming after the FOMC announcement, though these moves receded more quickly. Both the minimum and maximum prices tick up steadily immediately before and after the announcement before coming back down towards the end of the Chicago trading day. Additionally, the range between the two (calculated as the maximum – minimum / minimum) spikes at 13:00 hours when the announcement was made, but quickly returns to a negligible gap. Markets responded immediately to the rate increase before returning to more typical levels, suggesting that traders had anticipated this change and did not take long to position their exposures accordingly. An increase in price on the 10-Year Note future corresponds to a drop in the yield on the underlying U.S. Treasury Note. In this case, we see an increase in prices, which is associated with a drop in the 10-year yield, even as the FOMC announced an increase on the short-term fed funds rate. Markets were largely prepared for this rate increase, but the reaction of the 10-Year Note future can still bring some surprises.
The amount of bid and ask orders and quantities available on an hourly average basis throughout the day show a minor dip in depth in the hours following the FOMC announcement, reflecting a higher utilization of liquidity during the period of higher volatility and more frequent price changes as a result of the FOMC event. However, the amount available during these periods is in line with the levels seen early in the Chicago trading day. The only notable decrease in depth comes after the Chicago markets close (17:00 hours), when few participants are active and depth is expected to be lower. The reasonably steady hourly depth shows that there was more than sufficient opportunity to trade on either side of the market throughout the trading day and while markets absorbed the news of the rate increase. Markets were, unsurprisingly, very active after the FOMC decision was published, but it does not appear to have resulted in a reduction in trade availability.
Finally, the hourly implementation costs remained remarkably stable throughout the day, even as the rate increase was announced. With a minimum tick size of 1, various lot sizes of the 10-Year Note barely move from the minimum level until after Chicago hours, with the highest implementation cost 1.0155 ticks, on average. As Asian markets open and trading increases again, this quickly reverts to 1. The 10-Year T-Note didn’t experience any notable change when the FOMC announcement is made, meaning traders were able to execute without any meaningful increase to their costs, even as the other measures of volatility above increased.
As we’ve seen throughout this analysis, markets react quickly in response to scheduled event risk, such as the September 26 FOMC announcement of an increase in core interest rates. Knowing the exact timing of such an event allows participants to position themselves based on their expectation of the outcome. Markets are then poised to respond at the time of the event, frequently moving volume and prices dramatically. Even in a move that was widely predicted – correctly – by market participants, as this rate increase was, there can be uncertainty with regards to the long-term impact of rate changes. The 10-Year Note often experiences significant volume and price changes in the wake of FOMC announcements as traders position themselves based on their expectations for market changes in the longer term.
While the increased volatility that such events can bring could theoretically have an impact on market depth, we see no such market depth issues on September 26, 2018 as the FOMC announced its decision to increase interest rates. These hourly charts illustrate the efficiency of these markets to respond to the market events and quickly revert to more normal levels without a meaningful reduction in liquidity, ensuring traders are able to manage their exposures and risks even during changes to market dynamics.
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(s) 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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