Interest Rates

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Options Traders Increasingly Signaling Fed Rate Hike

Options Traders Increasingly Signaling Fed Rate Hike

The grizzled soothsayers trading options on Federal Fund futures have assigned greater odds recently to the Fed’s raising short-term interest rates – possibly as soon as December. A month ago, no expectations of the kind existed.
June 2007

In the options market where the savviest investors take apart conventional wisdom, the Federal Reserve is facing growing pressure to consider raising interest rates as soon as December.

Options on Federal Fund futures at the Chicago Board of Trade indicate a 41 percent chance the central bank will lift its target rate for overnight loans between banks to 5.5 percent from the current 5.25 percent, according to data compiled by Bloomberg. A month ago, they showed no expectations for an increase.

While the economy expanded at the slowest pace in more than four years in the first quarter, inflation remains at the top of the Fed's comfort zone, business activity has rebounded, the jobless rate is near the lowest in six years and stock indexes are setting record highs. Just three months ago, options traders speculated the weakest housing market in 16 years would force the central bank to cut interest rates to 4.5 percent by January.

"The economy is in better shape than people give it credit for," said Jamie Jackson, who oversees government debt trading at RiverSource Investments in Minneapolis, which manages $100 billion of bonds. "People exaggerated the pass-through effects of the housing weakness. If the Fed were to do something by year-end it would be a tightening."

The chance of at least one cut in the overnight lending rate between banks has fallen to 29 percent from 83 percent since the start of May, options prices show.
Read more on (Bloomberg)