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  1. If I think market expectations are too dovish and I expect rates to stay high for longer i.e. rate cuts by X central bank to happen in September for example (as opposed to whats priced in, e.g. May), what type of interest-rate swap would i put on to "benefit" from rates higher for longer?

  2. I've read that in this case i would want to receive Aug24 (fixed) and pay floating - is this right? Given I'm expecting rates to go down then, however, if I expect rates higher for longer, wouldn't I be making a loss given floating would be higher rates?

Please treat as if explaining to a 5 year old.

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    $\begingroup$ Ideally you would want to pay fixed on something, targeted for the area of the curve which is most misvalued according to your scenario. Im going to guess August 24 area. Then you might also want to leverage it by suggesting that the longer CBs wait the more the cutting might be required in which case an additional curve flattener might also be suitable, e.g. pay Aug 24 and receive Aug 25. $\endgroup$
    – Attack68
    Commented Feb 17 at 22:41
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    $\begingroup$ I agree with Attack68. The item you say you have read seems backwards: you want to receive the floating, which you expect to go up. $\endgroup$
    – nbbo2
    Commented Feb 19 at 13:13

2 Answers 2

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  1. The way to trade this is to put on a FOMC swap - where the start and end date is the meeting date, the underlying can be sofr or fedfunds(ff) and the notional can be the pv01 of risk you want to put on - say 100k/01.

Currently the market is pricing in a cumulative 25 bps of cut by June. Lets say you think this is wrong and that a string of strong inflation data will force the Fed to delay cutting rates. The dates of the meetings are here: https://www.federalreserve.gov/monetarypolicy/fomccalendars.htm

  1. So you enter into a June FOMC swap - start date: is 06/12/2024 and maturity is 07/31/2024 with 100k/01 of notional and you pay fixed and receive the floating (say fed funds (ff)). Now the market expects that the ff will set 25bps lower than its currently setting (https://www.newyorkfed.org/markets/reference-rates/effr) so they will pay you a lower rate in that June FOMC period - BUT if the FOMC doesnt cut rates as per your thesis, you will receive the prevailing higher ff rate and make money on this swap.

3.Do you want to work out how to close this swap to lock in the cash payment the day after the June meeting? hint: the nomenclature is a rundown swap.

  1. You can also put a second trade on to trade when you think rates will start to be cut as per @Attack68 and @nbbo2.
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If you expect interest rates to "not go down as much" as the market expects, then you would want to pay a fixed rate, which would reflect that rate reduction and receive a floating rate, which would rise more than (or at not go down as much as) the market thinks.

In other words, a fix-for-float swap would be fairly priced with a fixed rate representing market expectations of the changes in the floating rate. If you think the floating rate will not go down as much (or rise), then you'd want to lock in the fixed rate that the market thinks will be lower.

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