Bank Yield Index and constructing a term-SOFR curve

October 14, 2019 Chatham Financial

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An IBA January consultation aimed to address the credit-spread issue by proposing an index reflecting banks' cost of funds derived from wholesale, unsecured, primary-market funding transactions, including interbank deposits and institutional certificates of deposit, commercial paper, and secondary-market bond transactions. IBA would use that data to generate the U.S. Dollar ICE Bank Yield Index (BYI), a yield curve with one-month, three-month and six-month term settings.

The forward-looking credit spread would be constructed daily using a rolling average of the last five days of transactions.

The July update proposes placing the BYI on top of the implied term-SOFR yield curve, comprising one-, three- and six-month settings, based on methodology described in a working paper by Federal Reserve economists, Inferring Term Rates from SOFR Futures Prices.

Matt Hoffman, a director at Chatham Financial, said his firm has constructed daily, monthly and quarterly term SOFR curves since 2018 using SOFR futures, and incorporating Federal Open Market Committee meeting dates and the behavior of SOFR markets at key times, such as month's end. He said that Chatham is supportive of the model laid out in the Fed paper, adding that the approach resembles the construction of Libor term structures, which use highly liquid Eurodollar futures.

“Trading in near-term SOFR futures is more robust, so the short end of the curve is becoming more reliable. We're increasingly getting a better handle on term SOFR out to 1.5 to 2 years,” Hoffman said, adding that going out further requires modeling adjustments to proxy data.

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