You Can Trade the Fed Funds Rate in DeFi
The Fed Funds Rate (FFR) is probably the most talked about interest rate in finance. When you hear the media say “the Fed is raising rates” this is what they’re referring to. It’s the rate the Federal Reserve (Fed) sets a range for when it says it’s lowering or raising rates. The FFR is the rate banks charge each other to lend money, typically on a short-term overnight basis.
Interestingly, the Fed doesn’t directly control the FFR; it can only set the Discount Rate (what banks pay to borrow directly from the Fed) and provides only a target range for the FFR. If the FFR goes outside of those boundaries, the Fed intervenes. So it’s a rate created by market forces that’s subject to intervention when it creeps outside boundaries the Fed targets for it.
The FFR carries a lot of downstream effects for longer-term rates that influence the real economy. You and I really don’t care what JP Morgan and Wells Fargo charge each other for an overnight loan, but when it impacts the price of the 10-year Treasury or our 30-year mortgage rate it becomes front and center in the minds of everyone in finance when it changes.
And for the first time you can now trade and speculate on this rate in DeFi with the Strips SOFR market.
SOFR stands for Secured Overnight Financing Rate. It’s a secured interbank overnight interest rate and reflects a broad universe of overnight U.S. Treasury repo transaction activity. While it’s not directly the FFR, like the FFR the SOFR is also an overnight-lending rate between institutions that involves Treasuries and the two track very closely. As you can see in the chart below, trading the SOFR is an effective proxy for trading the FFR.
Here is a snapshot of the current SOFR market on Strips:
The floating rate represents the current SOFR market rate. The fixed rate is the projected/traded SOFR on Strips. As you can see from the 75 basis-point spread, our markets believe the SOFR will likely rise.
If you go long the SOFR, you will be receiving floating-rate payments and paying fixed-rate ones on your notional investment.
You will also be long the Fixed Rate from a spot trading perspective, and will profit if it rises.
If you short the SOFR rate, all the aforementioned is inverted. To better understand what the fixed rate on Strips represents, please read our explainer here (need to publish fixed rate explainer and link).
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The information presented here is meant for educational purposes, and is not investment advice. Any past performance, projection, forecast or simulation of results does not necessarily indicate any investment’s future or likely performance. The information and publications are not intended to be and do not constitute financial advice, investment advice, trading advice or any other advice or recommendation of any sort offered or endorsed by STRIPS Finance.