Aug 18, 2015

Navigating the Challenges of Prolonged Negative Interest Rates in Global Markets

As we continue to navigate the unchartered waters of prolonged negative interest rates on financial markets around the globe, derivative market participants are faced with a whole new world of challenges. Let’s take a moment to look back to January 15, 2015, when the Swiss National Bank (SNB) boldly brought the negative rates issue into the global financial news headlines. It took the world by surprise by announcing that it was ending the 1.20 floor on the EURCHF exchange rate. (Note: It had put the floor in place in September 2011.)

On the same occasion, in a move meant to ease the pressure on the Franc, the SNB announced that it was lowering the interest rate on sight deposits to –0.75% and shifting its target range for the 3M Libor rate downwards by 50 basis points to [–1.25%, –0.25%]. While the SNB move brought negative rates into the headlines, this was not their first appearance. At its previous press conference, the SNB set the interest rate to –0.25% and moved the lower end of its target range for the 3M Libor into negative territory. Since then, the CHF 3M Libor rate has been negative. Before that, the CHF overnight rate had regularly fixed in the [–0.05%, 0%] range for over three years. Examples of negative rates abound for other currencies as well. For the EUR, the European Central Bank’s (ECB) deposit facility rate was set at a negative level since June 11, 2014; the overnight EONIA rate and some OIS rates followed suit roughly three months later (when the ECB moved its depo rate further down), and the EURIBOR 1M rate is now negative. http://www.euribor-rates.eu/euribor-rate-1-month.asp

For the DKK, the Danmarks Nationalbank lowered its interest rate on certificates of deposit to –0.20% in July 2012, and the rate has stayed mostly negative since; the Tomorrow/Next (T/N) rate and the 1M T/N-indexed swap rate have been negative over roughly the same period.

Are Negative Rates Still Considered a Temporary Phenomenon?

The bottom line is that less than a year ago, the majority of market participants would have considered the emergence of negative rates a temporary phenomenon. However, the current consensus, especially in light of the SNB’s January 15, 2015 announcement, is that rates could stay negative for much longer and could even drop below today’s levels. What are the implications of this for today’s derivative market participants and what could this mean if this phenomenon continues into the months and year ahead—and possibly even beyond?

It is no surprise that negative interest rates remain a critically important issue in finance. Negative rates pose ongoing challenges by impacting some of the most basic calculations and procedures used by the financial community. For derivative practitioners, two prominent examples are challenges related to the quotation of option volatilities and volatility smile interpolation models, such as SABR.

Read the recently published Numerix Quantitative Research paper entitled, “Negative Rates: The Challenge and the Opportunity,” which explores some of the challenges that negative rates pose to the financial community and looks at how market practices are in fact evolving and becoming more innovative to address these challenges.

Blog Post - Sep 27, 2011

Capturing Stochastic Volatility: Key to Trading Inflation Derivatives

Need Assistance?

Want More From Numerix? Subscribe to our mailing list to stay current on what we're doing and thinking

Want More from Numerix?

Subscribe to our mailing list to stay current on what we're doing and thinking at Numerix

wf      
     
Subscribe Today!