Thursday, September 17, 2015

What to Do if Fed Does or Doesn't Raise Policy Rates Today


If you think the Fed will hike today you might consider selling -FFV5 / +2 x FFX5 / -FFZ5 (Oct/Nov/Dec fed funds future butterfly).  It trades -0.5 (half tic below even).  If the Fed hikes today, the Oct fed funds future will price the entire Fed hike, where currently it prices little.  The Fed would likely not move at the October meeting, even if it today it made a surprise 12.5 bps hike.  Going two meetings in a row would send a signal of consistent hikes to ‘policy path’ builders that the Fed doesn’t want to send right now.  If the Fed hiked 25 today, there is even less likelihood they would repeat in October.  The Fed might come back in either case with a rate move in December, which would affect pricing for Dec fed funds futures (negatively – lower), but leave the November contract subject only to the influence of the September action. 



Conversely, if you see the Fed as having a close call today and ending with a decision not to hike, but leaving a message (or not) that they are setting for an October response, you might consider buying +FFV5/-FFX5 (Oct/Nov fed funds future spread).  Such a position would benefit from the pricing of only marginal impact on the Oct fed funds future (Oct FOMC meeting is 28th).  Recent month end funding activity indicates a good chance that pressure on overnight rates will push fed fund effective several basis points lower at the end of October.  Even if the Fed makes an initial hike of 25 bps on Oct 28, the Oct Fed Funds will not trade far from 99.85).   An October Fed response would be priced entirely in November fed funds futures so the spread could move toward 20 bps from current 4.5.     


 This is not a recommendation or solicitation.

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