In a
blog post a couple of month ago, we noticed that “
SOFR is really alive again!” After several years of manipulation by the Federal reserve, the benchmark was showing signs that it was actually reacting to market developments.
It appears that those life signs are increasing. In Figure 1 we propose the graph of the SOFR and EFFR spread above target rate over a two-year period. The coming alive of SOFR is clearly visible.
Figure 1: Spread over target rate for SOFR and EFFR benchmarks.
If we look at SOFR’s and EFFR’s average spread (in bps) above target we have
| Period |
SOFR |
EFFR |
Note |
| 2023 |
5.95 |
7.92 |
|
| 2024 |
8.14 |
8.00 |
EFFR=8bps every day |
| 2024-H2 |
9.61 |
8.00 |
|
What does the market think about the above SOFR features? For that we looked at the forward SOFR-EFFR spread as quoted in the USD OIS market. Figure 2 displays data on the above spread for OISs with tenor 1, 10, and 30 years. The spreads are for SOFR + spread versus EFFR. A negative spread, as most of the time in the last two years, indicates that the market is ready to pay more for SOFR than for EFFR.
Figure 2: Spread for OIS basis swaps: SOFR + spread V EFFR.
SOFR is a secured rate while EFFR is unsecured. The two pieces of information above, the realised rates over the last 6 months and the forward looking market spreads, indicate that a secured rate is higher than an unsecured rate! We are quantitative finance advisors, not economical advisors; but the laymen in us thinks that “something is rotten in the State of Benchmark (Federal Reserve provided)”.
Moreover, at the view of Figure 1, the Fed sanctioned method to interpolate the SOFR curve described in Heitfield and Park (2019) and used in CME futures based SOFR Term rate, is less and less credible. Saying that the Fed has a biased view of the impact of the Fed on the market may not be a surprise.
Heitfield, Erik, and Park, Yang-Ho (2019). “Inferring Term Rates from SOFR Futures Prices,” Finance and Economics Discussion Series 2019-014. Washington: Board of Governors of the Federal Reserve System, https://doi.org/10.17016/FEDS.2019.014.
