Excell with Options: Navigating Fed Funds Using Ratio Spreads ahead of Sept. FOMC Meeting
Report highlights
- CME FedWatch Tool, absolute and cumulative probabilities
- Citi Economic Surprise Index vs. the generic 3 future for Fed Funds
- Citi Economic Surprise Index, Non-farm payrolls and Conference Board jobs plentiful vs. jobs hard to get
- Bloomberg Financial Conditions Index vs. the generic third Fed Funds future
- Expected return of a November 95.3125 / 95 1 by 2 put spread
U.S. labor data plays a pivotal role in shaping the Fed’s policy on interest rates, and traders may find it useful to know how the latest jobs numbers could influence the pricing of rate cuts. In this report, Rich Excell looks at asymmetrical risk-reward opportunities through the use of ratio spreads and Fed Funds as the September FOMC meeting looms large on the calendar.
Image 1: Various Fed Funds futures prices over the past year
The chart above shows the prices of the generic second, sixth and 12-month futures in the Fed Funds market. I have picked these somewhat at random but with the goal of showing the market’s expectation for rate cuts in the short, medium and long term. This allows me to see how quickly a Fed rate cut cycle develops and try to get a sense of how aggressively the market is pricing it. One can see in the generic 12-month futures that there are 200 bps of rate cuts priced into the next 12 months, with 50 bps expected to come in the next 2 months. This re-pricing of Fed expectations over the past three months is much more dramatic than the aggressive cuts that were priced into Fed Funds futures at the end of 2023, which were largely reversed over the first five months of 2024. This begs the question for market participants of whether the market is pricing in Fed policy that is too aggressive. If the economy does achieve a soft landing, are this many rate cuts needed?
Image 2: CME FedWatch, absolute and cumulative probabilities
