While base case remains reduction in borrowing costs, options market shows a 20% probability of increase
The US Federal Reserve. Traders have built up bets that the central banker could raise interest rates again, a once-unthinkable prospect that highlights a shift in market expectations after stronger than expected US economic data and hawkish comments from policymakers.
Traders’ central expectation is for one or two rate cuts of a quarter of a percentage point each this year, down from six or seven in January, according to pricing in the futures market.But following three months of higher than expected US inflation data, investors in a corner of the options market are beginning to take seriously the possibility – suggested earlier this month by former US Treasury secretary Lawrence Summers – that the Fed’s next rate move could instead be higher.
“I think it’s completely appropriate to factor in,” said Greg Peters, co-chief investment officer of PGIM. “I feel much better about the market pricing that in, versus the start of this year when it was just cuts in extremis.” Options pricing reflects a roughly 20 per cent chance of a rate rise this year, according to Ed Al-Hussainy, a rates strategist at Columbia Threadneedle Investments. His analysis was based on options that will pay out in the event of a rise in the Secured Overnight Financing Rate, a money-market benchmark which closely tracks Fed borrowing costs.
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