More and more traders bet on the Fed lifting its policy rate to 6%
According to Bloomberg, traders are betting the Fed’s policy rate will reach 6% by September. That’s almost a full percentage point above what the U.S. central bank had previously projected.
The hawkish bet came in response to last week’s much hotter-than-expected monthly jobs report, which prompted policymakers to adopt a “higher for longer” monetary policy stance to combat inflation, and this week’s remarks by a lot of Fed officials about the possibility of rates rising above policymakers’ projected median terminal rate of just over 5% for December 2022.
According to the data, a trader amassed an $18 million wager on Secured Overnight Financing Rate options on Tuesday with a September maturity date, targeting a 6% Federal Funds terminal rate, as reported by Bloomberg. Interest-rate swaps traders are pricing in a benchmark rate for that month of 5.1%, in contrast. According to Bloomberg, assuming the Fed tightened until September, the position would generate $135 million and break even at a key rate of roughly 5.6%. A similar deal saw buying on Wednesday as well.
More about the bond market
Contrary to what the bond market was hedging for immediately before the January nonfarm payrolls report, this move has a significant impact on the economy (i.e., they priced in rate cuts starting in the back half of 2023). And this is despite the Fed last week lowering the rate of rate rises for the second week in a row.
Given that peak-rate pricing for swaps traders increasingly resembles earlier Fed estimates, it will be intriguing to watch what Fed members forecast following the central bank’s next meeting in March. Of course, as Fed officials have often emphasized, reaching 6% by September will largely depend on upcoming economic data, particularly the release of the CPI report for January on February 14.
The 30-day Fed Funds futures price also indicates that the likelihood of higher rates is rising, but not by as much as 6%. The Fed Funds Rate Target Range would increase from 4.50% to 5.25% under CME’s FedWatch tool. CME’s tool currently prices in a 92.2% chance of a 25 basis point rate hike in March and a 60.8% chance of a second 25-bp increase in May. John Williams, the president of the New York Fed, disagreed with many of his colleagues and stated that raising interest rates to 5%-5.25% is still “quite sensible.”
