Pricing of swaps linked to scheduled Federal Reserve meetings now suggest that a quarter-point hike is more likely than not at the central bank’s next meeting in May. This is significant news for those invested in the markets, as the decision to hike interest rates will have an impact on the economy and financial markets.
The Federal Reserve, or the Fed, is the central bank of the United States. It is responsible for setting monetary policy in the country, which includes deciding on interest rates. The Fed’s monetary policy affects the entire economy, from consumers to businesses to financial markets. Therefore, any change in the Fed’s monetary policy is closely watched by investors, economists, and policymakers.
What are swaps?
Swaps are financial contracts that allow two parties to exchange cash flows. In the case of interest rate swaps, the two parties agree to exchange interest payments based on a fixed rate and a floating rate. The floating rate is usually based on an index such as the London Interbank Offered Rate (LIBOR).
Swaps are used by investors to manage risk and to speculate on changes in interest rates. They are also used by banks and other financial institutions to manage their balance sheets and to generate income.
Swaps linked to scheduled Fed meetings
Swaps linked to scheduled Fed meetings are a type of derivative that allows investors to speculate on the outcome of Fed meetings. These swaps are based on the federal funds rate, which is the interest rate that banks charge each other for overnight loans. The federal funds rate is set by the Federal Open Market Committee (FOMC), which is the Fed’s policy-making body.
Investors can use swaps linked to scheduled Fed meetings to bet on whether the FOMC will raise or lower the federal funds rate at its next meeting. If investors believe that the FOMC will raise the federal funds rate, they will buy swaps that pay out if the federal funds rate increases. If investors believe that the FOMC will lower the federal funds rate, they will buy swaps that pay out if the federal funds rate decreases.
Quarter-point hike likely in May
According to the pricing of swaps linked to scheduled Fed meetings, it is more likely than not that the Fed will raise the federal funds rate by a quarter-point at its next meeting in May. This would be the first interest rate hike since December 2015.
The Fed has been signaling for some time that it intends to raise interest rates in response to the improving economy and labor market. The unemployment rate has fallen to 4.2%, which is near the Fed’s estimate of the natural rate of unemployment. Inflation, however, has been running below the Fed’s 2% target, which has given some policymakers pause.
If the Fed does raise interest rates in May, it would be a sign that the central bank is confident that the economy is on a solid footing and that inflation will eventually rise to the target level.
Impact on the economy and financial markets
An interest rate hike would have several impacts on the economy and financial markets. First, it would make borrowing more expensive for consumers and businesses. This could slow down spending and investment, which could in turn slow down economic growth.
Second, an interest rate hike would make U.S. Treasury bonds more attractive to investors. This could lead to a sell-off in other assets, such as stocks, which could lead to a decline in the stock market.