Micro Treasury Yield Futures: Two Months In

Initially launched with a focus on the flagship 10-Year UST tenor, recent volatility and increases in short-end rates have turned focus toward the 2- and 5-Year points.

Rates are on the move! With 6.2% year over year CPI, a 4.6% unemployment rate, a record 10.4 million open job positions in the US, and massive bottlenecks across the country and the globe, rates are getting a lot more attention. The Fed announced they would begin tapering in November, and there is now a 64% chance of tightening by the June 2022 FOMC meeting according to the CME FedWatch Tool¹. 

Micro Treasury Yield futures were launched in mid-August as a complement to existing CBOT deliverable US Treasury Note and Bond futures, as a cash-settled alternative priced directly in yield². The focal point was the 10-year contract (10Y), long established as a leading interest rate indicator and liquidity source.

Average daily volume during these first few months has exceeded 11,000 contracts, regularly reaching as high as 20,000-25,000. Open interest has also trended upward, averaging several thousand contracts and beginning to show a cyclical monthly pattern as each new CUSIP is auctioned and becomes the new On-the-Run benchmark³.

Source: CME Group

Traders initially focused on the 10-Year tenor⁴ as the most widely referenced interest rate, though recently in October there has been increased interest in the 2-Year and 5-Year points as participants began to anticipate possible changes to FOMC policy and short-end rates reacted.

The 2YY and 5YY contracts have not yet matched the 10-Year in open interest, but inflation concerns have increased, and the market is looking for signs of a shift in FOMC target rates. As a result, near-term tenors are likely to remain in the spotlight, with volatility in absolute and relative yields.

Source: CME Group

Correlation to cash

With the Micro Yield futures settling to BrokerTec US Treasury benchmarks at the end of each month, it makes sense to examine how strongly they follow daily rate movements, to measure their usefulness as real-time hedging instruments.

Prior to the launch of these new contracts, the relationship between existing deliverable US Treasury futures prices and cash yields showed correlations exceeding 99.5% over a period from 2019 through mid-2020. Since launch, the Micro Yield Futures have performed well in that regard, with daily settlements showing a similar adherence to rates published by the US Treasury⁵.

The graph below shows the relationship across each of the three. Even in the early days of adoption, the contracts quickly react to rate movements such as those in October, making them a compelling risk management tool as the market digests new economic developments on a weekly or daily basis.

Source: CME Group

Inter-commodity spreads

One of the key properties of the new Micro Yield futures is their fixed risk exposure to yield changes.  Rather than a set notional with variable DV01, the contracts are each defined by a $1,000 contract value per full percentage point move in yield, leading to a fixed DV01 of $10 regardless of interest rate level – so mark-to-market reacts linearly even in a changing rate environment.

This streamlines calendar spreads, the monthly roll, and trading of inter-commodity spreads (ICS) between tenors, since the hedge ratio is always 1:1. When the shape of the curve is changing, such as the steepening of the short end and flattening of the long end shown below, the simplicity of ICS trading can help market participants sidestep legging risk brought on by outright volatility and remain hedged without complex calculations.

Source: CME Group

Micro Yield futures as rates normalize

With tapering of FOMC asset purchases, debates over the persistency of inflation, and labor market concerns all on the menu, there is the possibility that yield volatility is returning in earnest. For an increasing number of market participants who face previously unnecessary hedging needs after years of record low rates with little disruption, the Micro Yield futures present an accessible way to dial in precise exposure without the need for physical delivery⁶.

Contract specifications

Sources

1. CME FedWatch Tool:  https://www.cmegroup.com/trading/interest-rates/countdown-to-fomc.html
2. CME Micro Treasury Yield futures:  http://cmegroup.com/yieldfutures
3. BrokerTec US Treasury Benchmarks:  https://www.nexdata.com/indices/fixed-income/brokertec-us-treasury-benchmarks/
4. Micro 10-Year Yield futures:  https://www.cmegroup.com/markets/interest-rates/us-treasury/micro-10-year-yield.contractSpecs.html
5. US Treasury Daily Yield Curve Rates:  https://www.treasury.gov/resource-center/data-chart-center/interest-rates/pages/textview.aspx?data=yield
6. Micro Treasury Yield futures:  https://www.cmegroup.com/yieldfutures
7. All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.

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