What Is the Eurodollar Market? How It Works, Why It Matters - Part 2

If you haven't read yesterday's blog post, read it before continuing here.

Benchmarks: LIBOR to SOFR (short, high-level)

At some point, every floating-rate loan and interest rate derivative needs a reference rate. Markets need a number to plug into contracts. For years, that number was often the London Interbank Offered Rate (LIBOR).

LIBOR in one clean idea

LIBOR became the default benchmark for a world where bank funding and interbank lending were central to pricing. It was used across mortgages, corporate loans, and especially derivatives. The problem was that LIBOR relied heavily on bank submissions and assumptions, and over time the underlying unsecured term bank lending market became thinner and less representative. That created credibility issues and opened the door to scandal and manipulation concerns. So the market needed something more robust.

SOFR in one clean idea

SOFR (Secured Overnight Financing Rate) is based on actual transactions in the U.S. Treasury repo market. It measures the cost of borrowing cash overnight, secured by Treasury collateral. That shift matters because it changes what the benchmark reflects: LIBOR behaves more like a bank-credit-linked term benchmark, while SOFR behaves more like a secured, collateral-based overnight funding benchmark.

The headline: the measuring stick changed. But do not confuse that with "the eurodollar system ended." Offshore dollar plumbing still exists. What changed was the standard reference point markets use to price and hedge a lot of USD exposure.

Why the eurodollar market matters

This is the "so what" section. Here are the big ways eurodollars show up in real market behavior.

1. It helps explain why "dollar strength" can break things. Sometimes the dollar rises because the U.S. is strong. That's the simple story. But sometimes the dollar rises because dollar funding is tight. That is the eurodollar story. When offshore borrowers and banks need dollars urgently, the dollar can spike, not because growth is booming, but because liquidity is scarce. That is when risk assets tend to struggle.
2. It is a transmission mechanism for global stress. Because eurodollars sit across borders, stress can move across borders quickly. An offshore funding squeeze hits international banks, those banks tighten lending. That tightens credit conditions, which then spills into equities, credit spreads, and EM FX. This is why global markets can suddenly act correlated even when local fundamentals differ.
3. It shapes credit conditions even when central banks "ease". People love to argue about the Fed: "They cut, why did conditions tighten?" or "They paused, why did risk melt?" The eurodollar system is one reason. Monetary policy is not just the policy rate. It is also balance sheet capacity, collateral availability, interbank confidence, and wholesale funding conditions. If the offshore dollar system is contracting, credit can tighten even if policy is not aggressively restrictive.
4. It is the difference between macro headlines and actual plumbing. Markets often move on headlines. But big moves often come from plumbing: funding gets hard, rollovers fail, collateral becomes scarce, and balance sheets hit limits. Eurodollars are one of the core places where that plumbing shows up.

How to watch the plumbing

You do not need to stare at repo screens all day. You just need a few simple tells. A practical checklist:

• SOFR spikes or unusual volatility: SOFR is a window into secured funding conditions. Sudden jumps can be a hint that something in funding or collateral is tightening.
• Repo stress headlines: If you hear about repo market "dislocations," quarter-end balance sheet strain, or collateral scarcity, take it seriously. Those are not academic details. They are the pipes.
• Swap line chatter: When global central banks coordinate dollar liquidity via swap lines, it is usually a response to funding stress. It is a signal that the offshore dollar system is under pressure.
• Risk-off patterns that look like "dollar up, everything down": This is not always about growth. Often it is about funding. Eurodollar squeezes rhyme with this pattern.

The mindset

Instead of asking only "what does the Fed do next?", also ask "Is dollar funding getting easier or harder globally?", "Is the system expanding credit or contracting it?", and "Is collateral functioning smoothly, or is it strained?". If you ask those questions, you start reading volatility differently.

Closing: the clean takeaway

The eurodollar market is the offshore dollar banking system: dollar deposits and dollar credit created and intermediated outside the U.S. It exists because the world demands dollars, and offshore banking expands the reach of dollar finance. That expansion can be a tailwind in good times and a shock amplifier in bad times.

LIBOR was the old benchmark that sat naturally on top of a bank-funding world. SOFR is the newer benchmark rooted in secured Treasury repo transactions. The benchmark changed because the market structure changed.

But the big point remains: if you want to understand modern liquidity, risk cycles, and why stress can spread so quickly, you need to understand eurodollars. They are not a fun trivia term. They are the plumbing.