This year marks a major milestone for one of the great success stories in futures market innovation: the Ultra 10-Year U.S. Treasury Note futures contract.
The financial world looked very different back in early 2016 when CME Group launched Ultra 10-Year U.S. Treasury Note futures. A decade ago, the market was still digesting the Federal Reserve’s decision to raise rates from zero for the first time since the 2008 Financial Crisis. Benchmark interest rates in early 2016 were just 0.25% – very modest compared with today’s target range of 3.50% to 3.75%.
But even that 0.25% was a shock for a market used to a zero rate environment. As a result, the first few weeks of 2016 saw significant volatility: the S&P 500 experienced one of its worst-ever starts to a year amid fears of a slowdown in China and crashing oil prices.
Amid this economic uncertainty, CME Group took steps to reduce market risk in one key area: the hedging of the 10-year point on the interest rates curve. Often termed the ‘center of gravity’ for the global fixed-income market, the 10-year point is heavily used to price and hedge the world’s two largest non-Treasury debt markets: U.S. mortgages and corporate bonds.
Precision Strike
Before the introduction of Ultra 10-Year futures, hedgers generally relied on the‘classic’ 10-Year future (TY), which has a very wide deliverable basket: it accepts any Treasury note with a remaining maturity between 6.5 and 10 years. With the launch of Ultra10, hedgers had the ability to gain precise exposure to the critical 10-year maturity.
The Ultra10 has tighter delivery rules that only allow original-issue 10-year notes with at least nine years and five months remaining. This forces the contract to more closely track the true 10-year yield.
The Ultra10 launch filled a notable gap in the Treasury curve, and the response from the market was overwhelming. New futures contracts typically take years to build liquidity, but the Ultra 10-Year took off in days. Just four days after launch, volumes had surpassed 60,000 contracts, while open interest stood at 20,000 contracts. This made it CME Group’s most successful interest rate product launch of the decade.
Ultra Fans
This initial surge of volume in the Ultra 10-Year was driven by some enthusiastic early adopters. Mortgage and corporate bond desks made use of the precise hedging opportunities offered by the new contract, which closely tracked one of their points of maximum risk.
Treasury basis traders were also delighted to see a futures product that matched very closely to the ‘on-the-run’, or most recently issued, cash 10-year note. That tight relationship made it easier for basis traders to arbitrage more precisely the difference between the cash Treasury market and the futures market.
And rather than cannibalizing the existing ‘classic’ 10-Year as some might have predicted, the Ultra10 also led to significant relative value trades between the two contracts, boosting volumes in both. Relative value traders use the ‘TY/TN Spread’ between the classic and Ultra futures to express their views on the slope of the yield curve between the 7-year and 10-year points.
A Perfect 10 For Ultra-10 Futures
By the end of 2016, the Ultra10 had already established itself as a liquid benchmark with a deep order book, and the contract has kept growing from there. Ultra10 volumes now routinely exceed 700,000 contracts per day, making it the fourth most actively traded contract on the U.S. Treasury curve.
The market trades predominately on the screen but is deep enough that large asset managers can execute massive block trades without moving prices significantly. Now, 10 years from its launch, the Ultra 10-Year is considered a primary benchmark for the rates complex.
The Ultra10 futures contract has a lot to celebrate on its 10th birthday, but there are plenty of growth opportunities ahead as the contract looks toward its teenage years. Increased issuance of Treasuries continues to drive hedging as well as offering relative value opportunities, while the 10-Year point remains a cornerstone for the U.S. financial system.
At the same time, the Ultra 10-Year options market is also showing strong signs of growth, building on the deep liquidity of the underlying futures contract. As the market looks for new and more sophisticated ways to manage risk in a dynamic rate environment, the growth of Ultra 10-Year options proves that this ‘perfect 10’ story still has plenty of room to grow.
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