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Short-term rates, especially Fed funds, have shown significant changes in recent market dynamics. Previously, short-term rates were stable and almost compressed due to the low-rate environment of the past two years. However, this year has seen a shift with rates moving within the Fed policy target range, offering a more dynamic trading environment. The spread between various rates like Fed funds, Euro dollars, cross-currency swaps, and commercial paper has become more active, indicating increased trading activity within the range.
The Fed funds market, while historically significant, has undergone changes due to increased reserves in the banking system and the remuneration of reserves by the Fed. With lower activity than before the global financial crisis, the market still functions for interbank lending, with some banks engaging in arbitrage, leveraging the differences in rates to optimize their positions and regulatory requirements for certain banks to engage in traditional lending practices within the market.
The upcoming transition from LIBOR to SOFR presents a significant market change, affecting derivative contracts and market behavior. With SOFR being secured and LIBOR unsecured, the transition aims to align with more reliable benchmark rates. The transition process involves adjustments to contracts and shifts in market sentiments, with a focus on avoiding disruptions during the changeover.
The podcast delves into the intricate relationship between cash, collateral, and interest rates, particularly focusing on the impact on the software rate versus the federal funds rate. It highlights how the software rate, being more sensitive to cash and collateral balance in the system, reflects a higher level of scarcity of either component, influencing market dynamics differently than the federal funds rate. The discussion also emphasizes how these factors play a crucial role in shaping tradable spreads and influencing market participants' trading strategies.
The episode navigates the landscape of yield generation and risk management in decentralized finance (DeFi) and centralized finance (CeFi), shedding light on the complexities and challenges within this space. It underscores the risks associated with undercollateralized lending in CeFi and examines strategies to mitigate insolvency risks through effective reserve management. Moreover, it touches on the importance of treasury management in protocols like DAOs to ensure liquidity requirements are met while balancing asset diversification and risk exposure.
Interest rates are a key measure of the price of money, but as the plural suggests, there is one more than just one interest rate. Today Jack dives deep into the interest rate structure with whiz kid Kemen Linsuain, known commonly as DC Analyst, who knows a thing or two about the many different kinds of risk-free rates that punctuate the financial system.
Kemen tells of the Federal Funds rate, which is the nominal overnight rate that the Federal Reserve controls, to other rates within the Fed’s remit such as the interest on reserve balances (IORB) and the reverse repo rate (RRP). Kemen and Jack then discuss overnight interest rates not within the Fed’s control such as the Secured Overnight Financing Rate (SOFR), the London Interbank Offered Rate (LIBOR), and then other rates and derivatives such as Treasury bill futures and swap rates.
Note: the vast majority of rates discussed in this conversation are short-term rates with minimal amounts of credit risk, and should not be confused with corporate bond yield, mortgage rates, or commercial banking rates. Lastly, Kemen shares his thoughts on crypto, and tells Jack about his latest venture into crypto as a content creator at Gauntlet.
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About Gauntlet: https://gauntlet.network/
DC Analyst blog: https://dcchartbook.substack.com/
Latest chartback from DC Analyst: https://dcchartbook.substack.com/p/chartbook-17
Follow Kemen on Twitter https://twitter.com/AnalystDC
Follow Gauntlet on Twitter https://twitter.com/gauntletnetwork
Follow Jack Farley on Twitter https://rb.gy/uesguv
Follow Forward Guidance on Twitter https://rb.gy/cy0dki
Follow Blockworks on Twitter https://rb.gy/igyzsj
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Timestamps:
(00:00) Introduction
(01:08) Interest Rate Mayhem in 2022
(14:19) Repo Markets
(21:08) Curve Ad
(22:14) Secured Overnight Financing Rate (SOFR)
(37:03) Interest Rate Derivatives Market
(41:39) LIBOR to SOFR Transition
(50:14) Spread Between EFFR & SOFR (Effective Fed Funds Rate & Secured Overnight Financing Rate)
(55:26) Overnight Index Swaps (OIS) and Forward Rate Agreements (FRA)
(56:50) Negative Swap Spreads
(59:48) Term Premium
(01:02:12) Thoughts On The Fed
(01:06:53) Crypto & DeFi
(01:13:34) Where Did The (Crypto) Yield Come From?
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Disclaimer: Nothing discussed on Forward Guidance should be considered as investment advice. Please always do your own research & speak to a financial advisor before thinking about, thinking about putting your money into these crazy markets.
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