Source: Golden Ten Data
Author: Zaizi-kun
Options linked to interest rates for guaranteed overnight financing suggest that the possibility that the Federal Reserve will raise interest rates in September or December is around 18% and 20%, respectively.
The day after Federal Reserve Chairman Powell called rate hikes “unlikely,” options traders continued pricing, believing that the central bank's next move might be to raise borrowing costs by the end of the year.
Ben Emons, senior portfolio manager and head of fixed income at NewEdge Wealth in New York, said that as of Thursday, options linked to the Secured Overnight Financing Rate (SOFT) suggest that the possibility of interest rate hikes in September or December is around 18% and above 20%, respectively. Options traders also think there is a 3.1% chance of interest rate hikes by June, he said.
Options traders have been considering the risk of interest rate hikes and multiple rate cuts. However, they realized earlier than federal funds futures traders that the 2024 Federal Reserve policy may be stricter than expected. As early as February, when federal funds futures traders were still expecting to cut interest rates four to six times this year, SOFR traders were already considering the possibility that interest rates might rise in pricing.
Powell said at a press conference after the meeting on Wednesday: “I don't think the next policy interest rate will be raised.” He told reporters that policymakers need to see “persuasive evidence” that monetary policy is not tight enough to reduce inflation to the Federal Reserve's 2% target over time.
Powell listed the various situations that could occur. If inflation is “sideways,” the labor market remains strong, and officials have no greater confidence that price increases can continue to fall to 2%, then it may be appropriate to suspend interest rate cuts under such circumstances. But he also said, “The economy may take a different path, leading us to consider cutting interest rates,” such as the unexpected weakening of the labor market while inflation falls at the same time.
Following Powell's speech, “the market didn't fully take his word for it,” Emons wrote in an email on Thursday. “If the economy remains strong, interest rate cuts won't happen, thus increasing the possibility of interest rate hikes.”
According to data released on Thursday, the number of jobless claims barely rose to 208,000 at the beginning of last week, and is still fluctuating in the range, indicating that the job market is still healthy. Furthermore, unit labor costs, a key measure of wage levels, soared 4.7% in the first quarter, while economists' predictions were for a 4% increase.
Powell's remarks were more dovish than many expected, and they were made at a highly sensitive time before and after the November 5 presidential election. Allies of former Republican President Donald Trump are said to be developing a plan that would weaken the independence of the Federal Reserve if Trump is re-elected.
Dan Eye, chief investment officer of Fort Pitt Capital Group, said, “The impact of political factors is greater than the Federal Reserve is willing to acknowledge, and has played a role in distorting the Fed's tendency to keep interest rates unchanged and then relax policies. If the Fed returns to the rate hike model, interest rate hikes will drastically tighten the financial environment.”
As of this Thursday, the level of trading in federal funds futures suggests that interest rate hikes are simply impossible this year. In contrast, most federal funds futures traders believe that interest rates will be cut by 25 basis points or more drastically by September. The policy-sensitive 2-year Treasury yield closed at 4.87%, the lowest level in nearly a month, while the three major US stock indexes closed higher.
Keith Buchanan, senior portfolio manager at GLOBALT Investments in Atlanta, said Wednesday “was an excellent opportunity for Powell to present an idea or possibility of raising interest rates to the market.”
Buchanan said on the phone that if the FOMC is “ready and willing” to take this step as soon as possible, “he will spare no effort to ensure that this option is put forward.” If Federal Reserve officials eventually have to reverse Powell's current statement that rate hikes are unlikely, it would be the “worst case scenario,” as monetary policy remarks will then be “deemed unreliable,” especially after Powell described inflation as “temporary” in 2021.
Editor/Jeffy