Fed Forecasts Pose Risk For Soft Interest-Rate Futures Volume

Trading in futures contracts linked to U.S. interest rates could decline following a decision by the Federal Reserve to publish an explicit timetable for when it expects to take action.

The market for interest-rate derivatives already has seen a drop in trading volumes in recent months, in part because the Fed stated it won't raise the federal funds rate until at least the middle of 2013. Then on Tuesday, the Fed disclosed plans for a more permanent timetable, which could further pressure trading volumes as banks, multi-national companies and investment funds see less need to protect themselves against short-term swings in borrowing rates.

"The combination of telegraphing what they're doing here, and diminished uncertainty in the near-term will certainty hurt volume," said Jeff Horwich, a rate futures and options trader at the proprietary firm TradeLink.

The Fed starting next month will release a timetable for when it expects to raise the funds rate, given its projections for economic growth, unemployment, and inflation.

Falling volumes would hit the bottom line of exchange operator CME Group Inc. (CME), which makes its money from fees charged for each traded contract. Futures contracts tied to interest rates--from eurodollar futures to U.S. Treasury futures--made up 45% of all CME trading volume in 2011, making it the exchange's largest product line.

Volumes for those products dropped 15% in the fourth quarter of 2011 compared with the same period a year earlier. CME saw a decline of just 2% across all its products, from energy to currencies.

The Fed's new approach to forecasting could reduce volatility in key interest rates, causing analysts at Raymond James to voice caution with regard to interest-rate trading volumes in 2012 and reduce their overall earning estimates for CME this week.

While CME dominates interest-rate products, any fallout from the new Fed communication policy would affect NYSE Euronext (NYX) and the bank-backed platform ELX Futures LP, which list futures contracts modeled after those at CME.

Still, CME viewed the Fed policy changes as a good for its markets, saying in a statement it sees "greater transparency as a positive for markets, and for customers working to manage risks, not a negative."

Some traders voiced similar optimism. They said more transparency by the Fed could result in central bankers talking more freely about where they see rates going in the future, creating a more robust flow of information to fuel trading decisions.

"The more they talk, the more [traders] will react to what they say," said Lawrence Morgan, senior account executive for Archer Financial Services.

-By Howard Packowitz, Dow Jones Newswires; 312-750-4132; howard.packowitz@dowjones.com

--Jacob Bunge contributed to this article.

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