Futures vs FRAs inversion baffles market participants

Futures rates should always exceed those of the corresponding forward rate agreement, finance theory states. So why did the Euribor markets contradict this in May, with a so-called negative convexity adjustment? Laurie Carver reports

There is no such thing as a free lunch, the adage goes, but for a period in May, fixed-income markets seemed to think differently. The implied yield of futures contracts on the three-month Euribor rate fell below that of the equivalent forward rate agreement (FRA), violating standard financial theory and historical practice. This implied market participants needed to be paid an additional premium to enter a position that should – theoretically – only have positive income. “It’s like getting paid