Source: Zhitong Finance
Author: Xu Ran

After Federal Reserve Chairman Powell said interest rate hikes were “unlikely,” options traders are still predicting the possibility that the central bank may raise borrowing costs before the end of this year.

According to Ben Emon, senior portfolio manager and head of fixed income at NewEdge Wealth in New York, as of Thursday, options associated with overnight guaranteed financing rates (SOFR) showed that the probability of interest rate hikes in September or December was about 18% and over 20%, respectively. Emons also pointed out that options traders think there is a 3.1% chance of interest rate hikes in June.

The overnight secured financing rate is a broad measure of the cost of overnight borrowing secured by treasury bonds. SOFR is the successor to the London Interbank Borrowing Rate (Libor).

Options traders have been wary of the risk of interest rate hikes and multiple interest rate cuts. Despite this, they are ahead of their federal funds futures peers in predicting that the Fed's policy may be tighter than expected. As early as February, when federal funds futures traders were still expecting four to six rate cuts this year, SOFR traders were already predicting the possibility that interest rates might need to rise.

Powell said at a press conference on Wednesday: “I don't think the next move in policy interest rates will be likely to raise interest rates.” He told reporters that policymakers need to see “persuasive evidence” that the current monetary policy is insufficient to reduce the inflation rate to the Fed's 2% target.

Powell described the various situations that might occur. If inflation “moves sideways,” the labor market remains strong, and the confidence of officials that the price increase will continue to fall to 2% does not increase, then this will be a situation where interest rate cuts are delayed. But he also said that the economy may follow a different path, which may prompt us to consider cutting interest rates. For example, an unexpected weakening of the labor market is accompanied by a decline in inflation.

Emons wrote in an email on Thursday that after Powell's speech on Wednesday, “The market doesn't fully believe his words. If the economy remains strong, interest rate cuts won't happen, thus increasing the chances of interest rate hikes. The data released this morning shows why this is the case.”

According to a new round of data released on Thursday, the number of people applying for unemployment benefits for the first time only increased slightly to 208,000 last week, and is still within the healthy labor market. Furthermore, unit labor costs, a key wage indicator, rose 4.7% in the first quarter, exceeding economists' forecast of 4%.

As of Thursday, the level of trading in Fed fund futures suggests that interest rate hikes are simply impossible this year. By contrast, most federal funds futures traders expect to cut interest rates by at least a quarter or more drastically by September. The policy-sensitive 2-year Treasury yield fell to its lowest level in nearly a month, at 4.87%, and the three major US stock indices closed higher.

Editor/Jeffy