FOMC and RBA rate change probabilities
What do OIS and futures markets predict for the future of FOMC and RBA rate changes? This is a critical question for many traders and end-users of interest rate products.
In this blog, I will look at the two markets (USD and AUD) focusing on the OTC OIS and futures markets in both currencies. The next blog will look further into the past accuracy of the predictions immediately before the actual announcements.
Two exchanges publish expected probabilities: CME (for USD) and ASX (for AUD). In the case of CME, they publish the probabilities of various moves for at least the next 12 months. The ASX, on the other hand, only focusses on the next meeting.
The CME and ASX probabilities
The approach by each exchange is summed up as follows:
1) CME
Based on Fed Funds (EFFR) futures (i.e., monthly averages).
Uses an algorithm to calculate the probability of moves up and/or down at each meeting.
2) ASX
Based on RBA AONIA cash rate futures.
Uses an algorithm to calculate the probability of a move up or down at the next meeting.
While the approaches appear similar, in fact they are very different and based on quite dissimilar algorithms. I do not cover the algorithms used but some details for the CME can be found on their site.
I do note that there are some assumptions used by both exchanges in their calculations. The are described in the next 3 paragraphs.
CME uses the current Effective Fed Funds Rate (EFFR) which is currently 5.33% and within the target range of 5.25% – 5.50%. This is typical, in my opinion, as EFFR has tended to trade approximately 0.08% above the lower rate in the band for some time. But this is an assumption and therefore needs to be monitored.
ASX compares the calculated rate for the next meeting with the RBA Target Rate. However, the futures are based on AONIA (currently 4.07%) which has been trading at 0.03% lower than the Target at 4.10%. This is not adjusted in the ASX calculation at the moment so the ASX predicted move can be somewhat misleading as I show below.
Thes assumptions are very important to understand as they have the potential to significantly skew the probabilities relative to expectation.
A different approach
I take a somewhat different approach in each market and my calculations can differ from those of CME and ASX. I use futures prices as well as the OTC OIS market yields to ensure there is consistency across the two markets in each currency.
For example, the AUD OIS markets often trade in greater volume and longer maturities than the futures. There is a price difference between the 2 markets but this is within the bid/offer spread so I do not consider it an ‘arbitrage’.
The USD markets trade SOFR as well as EFFR in both futures and OTC OIS. With the transition from LIBOR to SOFR, the SOFR markets are much larger than the EFFR markets and so I conduct my analysis using SOFR futures and SOFR OTC OIS in place of the EFFR used by CME.
In the case of the futures markets, my approach is to calculate the step up or down at the next meeting to solve for each futures contract input. In some futures contracts, there are some days before the meeting, some after the meeting or all days are between meetings. These have to be correctly adjusted to solve for the probability.
Results and comparisons for USD
The USD results based on my calculations are quite interesting. These are shown in the following table.
All moves are from the rate today noting that EFFR and SOFR are different with EFFR around 3 basis points above SOFR.
I also add the OTC OIS implied moves alongside the SOFR futures implied move.
USD rates move probability.
The USD markets are quite consistent with the CME (EFFR) and my SOFR analysis aligning very well. This was expected but is reassuring nonetheless!
The analysis shows only about 30% probability of a 25-basis point rise between now and December with only 15% probability at the September meeting.
From January 2024 onwards, the probability of a 25-basis point fall in the Target Rate increases form 18% in January to near certain and an ~50% probability of a 50-basis point fall in May 2024.
Results and comparisons for AUD
Again, the results based on my calculations are quite interesting.
All moves are from the rate today noting that AONIA is currently 3 basis points lower that the RBA Target Rate. This difference has been in place since mid-2020 and has varied from 7 to 3 basis points.
I again add the OTC OIS implied moves alongside the AONIA futures implied move.
AUD rates move probability.
The comparison in this case is very interesting. The ASX calculation is 10% probability of a fall of 25-basis point while I calculate a 10% probability of a rise of 25-basis points!
How can this happen? It all comes from the basis of AONIA to the RBA Target where AONIA is 3 basis points lower than Target. Both the futures and OIS are based on AONIA, so the 3-basis points makes a difference.
My calculations show around 50% probability of a 25-basis point rise in RBA Target out to March 2024 noting the new RBA meeting dates from 2024.
Summary
In both the USD and AUD markets, there is good alignment of OTC OIS and futures markets for calculating the probabilities of cash rate moves in the future. This is expected but I do note these markets can differ and both need to be used in calculations as the volume traded in each market can be significantly different. I would tend to rely on the more-traded market for an accurate probability calculation.
The tables are informative and in the case of AUD, paint a more complete picture than the ASX calculations.
I plan to get these on the Martialis website and update them regularly.
Next analysis
The next blog will look back in time to see how accurate the market predictions were for FOMC and RBA rate moves (or pauses).