Interest rates are a very important financial measure for the global financial system. Financial markets and businesses are dependent on interest rates and how they effect the economic market. High interest rates increase the cost of doing business and force many businesses that are highly leveraged into bankruptcy. Low interest rates help the economy as well as the business grow. One of the ways to profit from the increase or decrease in interest rates is by trading interest rate futures. Most popular are the Eurodollars and and the Treasury Bills, Notes and Bonds.
As a futures trader, US Treasury Bonds Futures should be very important to you. But, in this decade the European Bond Market and the bond markets in China and Dubai are going to play increasingly significant roles. So the bond market is at the center of the financial world. At the center of the bond market is the US Federal Reserve (FED) and the way it raises and lowers the interest rates.
So, as a trader and as an investor, you need to understand how the bond market, the rest of the financial market, the FED and the interest rate changes work out. The understanding of this can help you in your trading and investing endeavors.
FED has got two policy instruments at its disposal. The first policy instrument at its disposal is the FED Fund Rate. This is the overnight lending rate that the banks charge one another for meeting their stipulated reserve requirements. FED sets the Fund Rate. The other policy instrument is the Discount Rate at which FED lends money to insolvent banks.
Suppose FED senses the inflationary pressure in the economy developing. It will increase the FED Fund Rate. With this increase the banks and the credit card companies. increase the prime rate the rate that they charge their best customers. When bond trader sense inflation increasing they start selling bonds. This increases the market interest rate. Mortgages and car loans are tied with the bond benchmark rates, so these rates also increase. This is how the increase by FED triggers a chain reaction that slowly works it way through the economy.
So, if you want to profit from the changes in the interest rates, you can trade FED Fund Rate Futures that get traded on CME (Chicago Mercantile Exchange). These futures contracts are a pure bet on the FED decision making at FOMC. You can also trade LIBOR Futures. LIBOR means that London Interbank Offer Rate. This is the rate that commercial banks charge each other and is widely used all over the world as a benchmark. Another popular contract is the Eurodollars and the EURYEN deposits.
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