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It is the story of interest at the moment. Rate hike expectations from central banks around the globe. Various sale side research parties publish often market implied rates hike. The magnitude and the probability.

I know the basic model via futures where you condition on different events, e.g. a hike or no hike and simply speaking comparing futures before and after a central bank meeting. However, depending on the futures these estimates are not very precise due to iliquidity (e.g. fed fund futures). So research often uses swaps to come with these market implied rate hikes / probability. I was wondering

  1. Which swaps are used for this purpose?
  2. What is the exact methodology behind it. Are there any references?
  3. For the probability one needs a model. What are some good references how this is usually done?

Curious to hear any insight on that topic.

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Which swaps are used for this purpose? - meeting date OIS. You can get runs from dealers and vendors will have some data.

What is the exact methodology behind it. Are there any references? - look at the effective rate, look at the meeting date OIS rate, observe the difference and make an inference about how much of the difference is due to rate expectations (given that effective and target rates no longer line-up the way they did pre-GFC).

EDIT: re references, try 'methodology' at this link https://www.cmegroup.com/trading/interest-rates/countdown-to-fomc.html# for one example. Other references I know of are not publicly available.

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  • $\begingroup$ thanks for your comment. Can you shed a bit more light on "ake an inference about how much of the difference is due to rate expectations (given that effective and target rates no longer line-up the way they did pre-GFC)". Moreover the methodology you linked is exactly the standard way via futures. Would be keen to get one for swaps and the mentioned inference about the rate expectations $\endgroup$
    – math
    Dec 3, 2021 at 8:40
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In reply to the followup question on 3rd Dec, heres an example...

Lets say the central banks meeting days are the following...

1st Feb 22

1st Mar 22

and currently the market data is as follows

AUD-OIS Fix : 4bp AUD-OIS Swap starting on 1st Feb22 to 1st Mar 22 (meeting date OIS): 8bp

this implies that the market is pricing in 4bp points of hikes following the 1st Feb meeting.

Typically, the "probability" of a hike is calculated by taking this 4bp that is priced in the market and dividing it by 25bp (Inherent assumption here is that central banks hike in clips of 25bp)

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