RESERVE BANK of India (RBI) has lately started playing a role as real monitoring authority over ever-erring banks when it has directed banks to calculate interest on daily-basis for savings accounts from 01.04.2010. RBI should now step further by re-introducing policy of uniform and same interest-rates for at least all public-sector banks on deposits and advances. Nationalised banks may compete by offering better and advanced services rather than on gimmicks of interest-rates. Interest rates are important for everyone that includes, consumers, speculators, hedgers, businesses, economist, bureaucrats and politicians. Returns in financial markets are dependent on interest rates. As a trader, you must keenly watch any change in these rates as they can drastically affect your trading returns. One way to profit from them is by trading interest rate futures like the Treasury Bills, Notes and Bonds and the Eurodollars!

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 the power to increase or decrease the interest rates in the US economy. Now, everyone knows this. FED has got basically two policy instruments that it can use to achieve its policy objectives. The first one is the setting of the FED FUND RATE. FED FUND RATE is the overnight lending rate in the commercial bank market that the banks charge each other for meeting the stipulated reserve requirements set by FED. So FED can increase or decrease this rate at its discretion. This is a short term interest rate as you might have imagines that is simply the overnight rate. But it has the potential of setting a chain reaction in the economy that than changes the medium as well as the long term interest rates in the economy. The second policy instrument at the discretion of the FED is the Discount Rate Window. This facility is only offered to banks that are facing insolvency problems by giving them cheap loans at least cheaper than the market.

Now how does the FED FUND RATE trickles down through the rest of the economy. Let's see how it works. Suppose, FED is worried about the overheating of the economy and the rise in inflation. One of the primary jobs of the FED is to control inflation in the economy. So, the FOMC decides to increase the FED FUND RATE. This increase forces the banks and the credit card companies to increase their prime rates that they charge their best customers. Now, when bond traders sense an increase in the interest rates, they start selling their bonds in the market. This increases the market interest rates further. Auto loans and the home equity plus mortgage loans are tied with these bond benchmark rates, so they increase as well. So, you can see, how a chain reaction develops in the economy. This increase trickles down through the economy with a time lag that might be as long as from six months to more than one year.

So, if you want to profit from the changes in the interest rates, you can trade FED Fund Rate Futures that get traded on CME (Chicago Mercantile Exchange). These futures contracts are a pure bet on the FED decision making at FOMC. You can also trade LIBOR Futures. LIBOR means that London Interbank Offer Rate. This is the rate that commercial banks charge each other and is widely used all over the world as a benchmark. Another popular contract is the Eurodollars and the EURYEN deposits.