Thursday, April 30, 2015

Fed Funds May Offer Positioning Strategy

The Fed Funds futures market is worth keeping an eye on.  Even though the volume traded in these futures is not huge, they often provide clues to mis-pricing.  The FFU5-FFV5 (September 2015-October 2015) is as tight as it has been since November 2013 trading 4-4.5 bps wide. 

The FOMC meets on September 17 and October 28.  So if one assume the Fed will raise rates in September for the first time, the policy rate would move to range 25-50 bps on September 17, with the fed funds effective moving toward center or 37.5 bps. 

Pricing: FFU5 would have roughly half a month (Sep 17th is toward mid-month) to price a 25 bp hike, so roughly 12 bps and might be expected to settle toward 99.75 under the above scenario.  The Oct fed funds contract would benefit from the entire 25 bp hike in Sep and might benefit from a projection for a further Fed move in October, though the late-month October meeting means that only half a point or so might be added.  We might price Oct to 99.61.  That makes this spread a possible 13 bps rather than 4.5.  (99.75-99.62).  




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