For some time, we have reported about the volatility of the SOFR / target spread in the USD market (see for example SOFR is getting more alive!). Today we can even report on some volatility of the EFFR / target spread!
The news has even reached the main newspapers like the Bloomberg and Financial Times.
The EFFR has been at target plus 8 bps for several years. Only in the last months was there some volatility, with the spread going up to 12 bps. The target rate targets the EFFR, in that sense we can say that the targeting has been very effective. But in reality it sounds like a self fulfilling prophecy. The volumes are quite small (see below) and the number of participants restricted. The bid/offer implied by the 25/75 percentile is 1 bp, not a realistic number for a real cash market.
When comparing with the overnight repo market represented by SOFR, one can see the difference with a “real” market. Bid-offers are in the 10 to 15 basis points and the rates change each day. There are patterns, in particular at month-end, but also you can see the market stresses.
Figure 1 and Figure 2 represent the spread between the different rates and the lower bound of the target range. In Figure (1) the date since January 2023 is represented and in Figure 2, the focus is on the year 2025.
Figure 1: Spread over target rate for SOFR and EFFR benchmarks. Data since January 2023.
Figure 2: Spread over target rate for SOFR and EFFR benchmarks. Data since January 2025.
In the graphs, we have also added the Interest On Reserve Balance (IORB), which is the interest that banks receive from the Federal Reserve for balances in their account. Since 2021, there is no distinction between the mandatory reserves and the excess reserves, all of them receive the same interest. Since that date, it has always been at Target plus 15 basis points.
Given the lack of movement in the EFFR / Target spread, it has been suggested that the Target should maybe be changed to SOFR (Options for modernizing the FOMC’s operating target interest rate). Even some Federal Reserve (of Dallas) economists acknowledge that the EFFR are not really “effective” anymore by indicating “interbank loans are far less important to the financial system than they once were” and “connections between the fed funds market and broader money markets have grown fragile”.
This leads us to the volumes underlying the two main overnight indices in the US market displayed in Figure 3. As can be seen in the graph, the volume underlying EFFR has been roughly unchanged, around 100 billion USD a day, for a long time. Over the last 3 years, the volume underlying SOFR has increased steadily from 1,000 to 3,000 billion USD a day.
Figure 3: Volume underlying EFFR and SOFR since 2018.
Don't hesitate to contact us regarding the modelling of overnight rates.
