Volatility of projected Euribor and hedging instrument prices

The backtesting analysis of the projected Euribor curve highlights that it is highly volatile, inducing strong variations in interest rate hedging instruments prices.

The animation below illustrates the different variations in the projected 3-month Euribor curve at different dates.

The price of interest rate hedging instruments (swaps or caps) depends on the level of projected rates, which in turn is determined by equilibrium between supply and demand on the debt market (to simplify). Therefore, any change in this yield curve has a direct impact on the price of hedging instruments.

The curve presented above is made up of a historical part (left side) and a projected part (right side), taken at several dates. The projected portion is subject to variations induced by changes in market expectations, particularly related to central banks actions and statements.

A lot of analyses of this curve are possible in order to understand the impact of exogenous elements such as the US/China trade war and the Corona virus on hedging instruments prices:

Horizontal analysis: Forecast date at which the euribor should go back above 0%: this date regularly shifts several years in a few days, to the left or to the right.

Vertical analysis: Rises and falls of this curve: we frequently see weekly variations of approximately fifteen basis points (bps), sometimes more, for a given point of the curve. Since all the points do not move in parallel, the curve is constantly sloping or flattening.

This volatility means that the market has no stable (or reliable) forecast for the future of Euribor.

These variations have a relative effect on prices of hedging instruments, that is even stronger as those prices are currently very low (basis effect).