As the market has begun to price rate cuts into 2024, where the CME FedWatch tool now predicts up to six cuts of 25bp each through 2024, some customers may see those returns diminish.
Should customers want to hedge against additional pricing of rate cuts next year, they may consider buying CME Group T-Bill futures to lock in current pricing of yet-to-be-issued T-bills.
T-bill yields are naturally well correlated to other short-dated interest instruments, in particular overnight SOFR, as represented by CME Group One-Month SOFR futures (SR1) and Three-Month SOFR (SR3) futures. These provide a natural hedge for general interest rate levels that can be tailored through different contract combinations to offset interest rate risk for a variety of T-bill portfolios.
However, users of T-bills will find that T-Bill futures provide a more specific hedge of expected T-bill yields.
Consider a customer who expects to receive cash in September 2024 and is planning to buy T-bills ahead of deploying that cash into investment opportunities at a later date.
Current pricing* of the Sep 2024 T-Bill futures contract is at 95.745, implying a discount yield of 4.255%. A customer who is concerned that expected rates on T-bills may fall further could hedge such a view by buying the futures where each future purchase represents a hedge of approximately $1mm notional amount.
Supposing our hypothetical customer had expectations of a need to manage $75 million in cash, they may buy 75 futures contracts at 95.745. Now suppose that rates do fall further than is currently priced such that the auction of 13-week T-bills in the third week of September 2024 clears at a rate of 4.00%. Our customer would see their futures contract final settle to a price of 100 – 4.00 = 96.00. As a result, the customer would profit by 25.5 basis points where each basis point is worth $25. The end result would be a gain on the hedge of 75 (no. of contracts) x 25.5 (basis points) x $25 (value per contract per basis point) for a total of $47,812.50.
*as of January 4, 2024
Image and article originally from www.cmegroup.com. Read the original article here.