Anything that anyone does in the financial markets is based on interest rates. When interest rate increase, the cost of doing business increases and when interest rates are lowered, economic growth gets energized. The relationship between the rising and falling interest rates makes the markets in interest rate futures, Eurodollars and Treasury Bills, Notes and Bonds important for everyone including consumers, speculators, hedgers, economists, bureaucrats and politicians.

As a futures trader, US Treasury Bonds Futures should be very important for you. However, in this decade the European Bond Market and the bond markets in China and Dubai are going to play increasingly significant roles. So the bond market is at the center of the financial world. At the center of the bond market is the US Federal Reserve (FED) and the way it raises and lowers the interest rates.

The connection between the bond market, the FED and the rest of the financial markets is fundamental to understanding how to trade interest rate futures and how to invest in general. FED does not control the long term interest rates in the markets. So how does FED influence the interest rate in the economy?

FED has got two policy instruments at its disposal. The first policy instrument at its disposal is the FED Fund Rate. This is the overnight lending rate that the banks charge one another for meeting their stipulated reserve requirements. FED sets the Fund Rate. The other policy instrument is the Discount Rate at which FED lends money to insolvent banks.

Suppose FED senses the inflationary pressure in the economy developing. It will increase the FED Fund Rate. With this increase the banks and the credit card companies. increase the prime rate the rate that they charge their best customers. When bond trader sense inflation increasing they start selling bonds. This increases the market interest rate. Mortgages and car loans are tied with the bond benchmark rates, so these rates also increase. This is how the increase by FED triggers a chain reaction that slowly works it way through the economy.

Now the most important interest rate futures are the FED Fund Futures. These futures contracts get traded on the Chicago Mercantile Exchange (CME) and are a pure bet on what the FED is expected to do with the interest rates. The second most popular interest rate futures are the LIBOR Futures. This futures contract is based on the London Interbank Offer Rate (LIBOR) the rate charged between commercial banks. EUROYEN deposits are also popular!