As a result of being outside U.S. borders, eurodollars are outside the jurisdiction of the Federal Reserve and subject to a lower level of regulation. As eurodollars are not subject to U.S. banking regulations, the higher level of risk to investors is reflected in higher interest rates.This drives it up.
The more I observe this market the more baffled I am by it. Today for instance, the Fed hiked by 25 bps and talked about raising three more times between now and 2020. That should send the fed rate to 3.25%, and 3-month USD LIBOR should be at least 3.5%. That should have the December eurodollar contract at 96.5 (100-3.5). Yet, all the eurodollars (except the very front one) have been rallying the last few weeks and actually rallied on this confirmation of the Fed bias to hike. Dec20 GE now sits at 97.37. Isn’t that way too high, considering we all know where LIBOR is going to be at the time of expiration. That price is too high even if the Fed hikes just once, let alone three times. I feel like saying how dare this market go up when it has to settle well below its current value. I guess it’s a case of the market remaining irrational longer than I can remain solvent. Concerning the preceding comment, I would think the additional risk to investors that stems from lighter regulation would result in a lower eurodollar price, rather than a higher one. The richer interest rate is subtracted from 100, resulting in a lower price. But lately, ED is rallying in price, offering up dollars at a discount, perhaps an expression of flight to safety. Funny how it doesn’t trade much like the short end of the bond curve. Today, among other days, the 30 year price is up while the two and five year prices are down. Eurodollar is up by a good clip, along with a 30 year.
This sounds like nonsense. What are these strict regulations that apply in the US compared to elsewhere?
The market for GE has different expectations for the path of US interest rates than the Fed has expressed.