Rate Traders Betting on Fed Dots Move Will Get Their Answer Soon

(Bloomberg) — Short-term interest rate derivatives traders are piling up bets that could pay off or turn sour once the Federal Reserve releases its updated point chart on Wednesday.

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As the Federal Reserve begins to ponder monetary policy tightening, predictions by various central bank officials for the position of federal funds in each of the next three years have the power to spark lucrative price swings in Euro-dollars. futures and options . Last week’s volume in the December 2024 contract was the third highest in its history, suggesting that’s where the biggest potential rewards lie.

The forecasts will be released along with the Fed’s monetary policy statement as part of its summary of economic projections, at 2 p.m. in Washington on Wednesday.

Major banks are marketing transactions that anticipate an aggressive shift in the dots. Goldman Sachs Group Inc. and Toronto-Dominion Bank recommended tactical short positions in short-term interest rate swaps this week, paying biennial OIS in dollars. The TD version includes receiving the British Pound Equivalent. Morgan Stanley has recommended a steepening of the euro-dollar curve with respect to its December 2024 contract since June, based on the discrepancy it sees between the expected pace and timing of Fed rate hikes. Trading has been largely unprofitable thus far, but dot-plot revisions could change that.

Goldman says Fed points are moving up rather than down; more than two hikes projected in 2024 would question the central bank’s inflation tolerance threshold “and push relevant interest rates forward,” strategists Praveen Korapaty and Avisha Thakkar wrote in a report. TD expects 2024 dots to anticipate an increase of 50 to 75 basis points, compared to 40 basis points currently priced in.

Only three Fed officials need to raise their unchanged points for 2022, making the quarter-point rate hike the new median for next year. The euro-dollar curve is already anticipating the change, based on the spread between the December 2021 and December 2022 futures. Based on the June 2023 contract price, a second increase is expected in mid-2023.

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