3
$\begingroup$

With the transition from LIBOR to SOFR, what is the market standard for building a Fed Funds curve? In the "old days", I believe that one would use Fed Funds futures for the front-end (i.e. 3-6 months or so), then use the Fed Funds / LIBOR basis swap for the longer-dated tenors. Is there a SOFR / Fed Funds basis swap that can be used to build the Fed Funds curve? If not, what's the best way to build the Fed Funds curve?

Note: I'm not referring to the OIS curve (which, by definition, is compounded). I'm referring to a curve that can be used to price non-compounded Fed Funds swaps.

$\endgroup$
5
  • 2
    $\begingroup$ To my knowledge, Fed Funds swaps continue to trade heavily: as long as banks will participate in the overnight unsecured financing market (i.e. Fed Funds), there will be need to hedge this financing on a term basis. To my knowledge, SOFR (i.e. the secured overnight financing rate) only accommodates the financing needs of banks partially, with the remainder being accommodated by the unsecured borrowing (i.e. at the prevailing Fed Funds rate). I believe that the Fed Funds swap curve is liquid and so doesn't need to be built as a "spread", it just exists as a stand-alone curve. $\endgroup$ Commented Jan 19, 2022 at 16:54
  • 2
    $\begingroup$ PS: I would really appreciate if someone who trades the actual Fed Funds curve or builds it as a quant could answer properly, the above points are based just on my general knowledge of the subject, i.e. browsing the CME website to see their cleared products, etc. I never traded the Fed Funds curve. Hope a practitioner will provide a more thorough answer. PPS: CME list "SOFR-Fed Funds" spread as a product, so if the spreads are more liquid than the actual Fed Funds swap of the same tenor, probably the spread would be used for the curve. $\endgroup$ Commented Jan 19, 2022 at 16:55
  • $\begingroup$ I copy Jan's comment; I have mainly seen curves that simply use liquid FedFund (compound) vs. Fixed Swaps. Re your comment on the non OIS Curve / compounding: could you please clarify what you mean? I imagine that regardless of your "input" instrument, your ultimate goal in bootstrapping will probably be to produce daily forward rates anyways, which you can then use for whatever you like (= averaging, compounding, single-reset, lookback, etc. style coupons). $\endgroup$
    – KevinT
    Commented Jan 19, 2022 at 17:06
  • $\begingroup$ I was under the impression that the Fed Fund basis swap market (e.g. SOFR/FF and LIBOR/FF) was more liquid than the outright Fed Fund fixed swap market. Is this the case? $\endgroup$
    – equanimity
    Commented Jan 19, 2022 at 17:10
  • $\begingroup$ Existing LIBOR/FF swaps should fall back to SOFR/FF anyway (with SOFR discounting) sooner rather than later (so fresh SOFR/FF swaps would make sense). $\endgroup$
    – ir7
    Commented Jan 19, 2022 at 20:28

0

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service and acknowledge you have read our privacy policy.