The 10-Year Note: A Futures Market Revolution

At a Glance

  • The flagship treasury contract rose during 80s interest rate turbulence
  • The 35 year-old market had the highest volume debut ever

 

Few futures contracts have done as well as the 10-year Treasury Note.

When it debuted on May 3, 1982, it set a trading-volume record with 33,502 contracts traded, a figure still unsurpassed for a first trading day. In the intervening years, it has become the third-most actively traded futures product listed on the CME Group exchanges, surpassed only by the Eurodollars and e-mini S&P 500 stock index futures. It is the flagship long-term interest rate contract, and is used widely as a reference for government securities, mortgage rates and corporate-bond issuance.

“The 10-year T-Note contract has lived a charmed existence, and it was born of a really fertile environment,” says Fred Sturm, executive director of financial research at CME Group.

Emerging From the Shadows

1982 was a turbulent time in government finance. It was three years into then-Federal Reserve Chairman Paul Volcker’s decision to hike interest rates to tame inflation and cope with the ballooning federal debt.

The Chicago Board of Trade already had listed its Treasury bond futures, and the CBOT membership were very excited about the 10-year T-Note contract’s launch.

In the book Market Maker: A Sesquicentennial Look at the Chicago Board of Trade by William D. Falloon, these new interest rate futures contracts were a “revolution,” which quickened once Volcker’s plan was in place.

The 10-year Note contract, Falloon wrote, “appealed to government securities dealers and corporate debt underwriters issuing intermediate paper. Indeed, a May 5, 1982 auction of $4 billion of 10-year notes made clear intermediate notes were an important part of the government’s quarterly funding operations.”

After its auspicious debut, the 10-year Note contract attracted healthy liquidity, but for nearly 20 years it labored in the shadow of the Treasury Bond contract, which was the leading long-term interest rate product of the time. But a surprising development gave the 10-year Note contract its chance to step out of the shadows.

Because of Clinton-era budget surpluses, the U.S. Treasury Department announced unexpectedly in October 2001 that they were going to cease issuance of new 30-year bonds, which would significantly impact the T-Bond contract because the deliverable supply of Treasury bonds eventually would dry up.

“I can recall attending meetings at the Chicago Board of Trade. It was like observing Elisabeth Kubler-Ross’s five stages of grief. There was a lot of denial,” Sturm jokes.

Liquidity quickly moved to the 10-year Note pit – and stayed there. Some of the local traders who provided liquidity in the Bond pit joined the 10-year Note pit and volume there grew quickly.

In 2000, trading volume was 43.9 million 10-year T-Note contracts versus 60.1 million Bond futures. A year later, 10-year Note futures volume surged, nearly matching Bond futures volume. By 2006, when the U.S. Treasury  resumed issuing 30-year bonds, the 10-year Note contract had become the undisputed long-term interest-rate volume king.

In 2016, volume was 350.7 million in 10-year Notes versus 70.2 million in Bond futures (now known as the “Classic” Bond contract). In fact an offshoot of the 10-year Note, the Ultra 10-year, launched in 2016 to similar success. Following its first week of launch, more than 60,000 contracts were traded, making it the most successful interest rate futures contract launch in the last decade.

A Beacon for Interest Rates

Having the 10-year Note futures as the flagship interest rate contract “should have made sense for all sorts of reasons,” says Sturm, noting the 10-year term to maturity is a key issuance point for most other sovereign debt, which makes it easier for a global fixed-income investor to trade.

The 10-year Note  is also a reference point for valuation of aged debt instruments, such as 30-year bonds with six or nine years of remaining term to maturity. That area of the yield curve is viewed as a region of “chronic liquidity drought” as it’s hard to trade anything in size, says Sturm.

“One of the great virtues of our 10-year Note future is it serves as a beacon in a shadowy stretch of the Treasury yield curve. It enables participants to do something that would be quite onerous to do otherwise,” he says.

Read More about CME Group’s Products of Progress

Alan Bush, senior financial economist, ADM Investor Services, says one of the main uses for the 10-year Note contract is as an indicator for mortgage-rate direction.

“It’s probably the benchmark for 15-year mortgage rates. The average (longer-dated) mortgage is paid off or refinanced within 10 years, so the 10-year note is a great bellwether to measure interest-rate change,” he says.

Bush said he also likes to use it to analyze the yield curve, noting the 2-year Note and 10-year Note futures are very popular to compare against each other for this yield-curve analysis.

“For a longer-term view, you want to use the 2-10 yield curve analysis which can help for any longer-term prediction of where the economy is going,” he says.

Weathering the Crisis

The 10-year Note has also strengthened in volume and liquidity since the 2008 global financial crisis, Sturm says.

Regulatory changes such as the Basel III bank capital adequacy requirements and Dodd-Frank Act requirements, including moving interest rate swaps to exchanges or swap execution facilities, have bolstered the contract.

“It’s simply more cost-effective, less demanding on your balance sheet to hold a futures contract than to hold an asset,” says Bush.

The 10-year Note contract has distinguished itself since the 2008 financial crisis, just as it did in those early days back in the 1980s.

“It came along exactly when people needed it,” says Sturm. “In most ways, it’s moved from strength-to-strength ever since.”

 

Debbie Carlson has focused on commodities for much of her writing career. She spent more than a decade at Dow Jones covering the Chicago-based futures exchanges. As a Dow Jones editor, she worked closely with The Wall Street Journal and Barron's in planning commodities coverage.

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