Some traders are betting that money-market rates will skyrocket as the end of 1999 approaches because the supply of money will grow scarce as bankers become reluctant to make loans at the end of the century.
"People are doing this trade under the theory that money over the turn of the year is going to be very expensive because of the millennium," says Kevin Bespolka, managing director of global foreign exchange and debt proprietary trading at Merrill Lynch International.
The "millennium bug" refers to software that recognises years using just the final two digits instead of all four. In systems using that software, a date in 2000 could be interpreted as 1900, throwing interest-rate and other calculations into chaos. Banks may be reluctant to lend at that time unless they are convinced their computers won't go haywire.
Recently traders have been selling December 1999 contracts and buying the September 1999 and March 2000 contracts, say Mr Bespolka and other traders in London and New York.
The trade has already skewed the implied yields on three-month Eurodollar and Euromark contracts which expire in September and December 1999 and March 2000. The spread between the yields on the September and December 1999 contracts has risen from a three-month average of about 8 basis points to as much as 14 basis points in the past week.
In a so-called barbell trade, an investor buys two securities with different maturities and sells a third security with a maturity date between the two. When the gap in value between what the investor owns and what has been sold widens, the trade makes money. According to Bloomberg calculations, the gap in value between two December 1999 contracts and one each of the September 1999 and March 2000 contracts has averaged 9 basis points during the past three months. In the past week the gap has doubled to 18 basis points.
"It makes sense that there will be a liquidity squeeze as we get close" to the end of 1999, says James Craigen, head of money markets at Gulf International Bank.
Still, Mr Bespolka and others doubt that the spread will continue to widen. "At current levels, this trade already prices in very expensive year-end money," says Mr Bespolka. "It's a silly trade. To short a three- month Euromoney future 18 months out because of concerns over rates in the few days around year-end is overkill."
The moves in interest-rate futures are the latest examples of speculation about the extent to which the millennium bug might hurt financial institutions and other businesses that rely on computers.
Companies such as US-based Keane, Computer Horizons and Compuware, which specialise in fixing the software problem, have seen their shares more than double in the past year on expectations that other companies will pay up to make sure their computers don't go into a time warp.
Banks and securities firms are already spending millions of dollars to avoid millennium-related difficulties. JP Morgan plans to spend about $155m (pounds 93m) on the problem this year, and spent about $95m last year, to prepare its systems for the year 2000, according to documents filed with the Securities and Exchange Commission.
Norwest, the 11th-largest bank in the US, said it would spend between $100m and $125m to help its computers understand dates after 31 December 1999. Bankers Trust New York will spend $180m to $230m in the next two years. Citicorp is spending $600m from 1997 to 1999.Reuse content