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Trading Expectations of Delayed Rate Cuts with Pay-Fixed Swaps

Article Quant Q&A · Author: user131113
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Summary

The document explains how to express a view that policy rates will stay higher for longer than the market expects. In a fixed-for-floating swap, paying fixed and receiving floating benefits if the floating rate over the relevant period is higher than the rate implied by the fixed leg. The responses describe using a meeting-dated overnight-index swap, such as one tied to a central-bank meeting, to isolate the expected rate decision and subsequent accrual period. They also mention alternatives including futures spreads, forward-rate agreement spreads, curve structures, and short-dated overnight-index swaps.

The key distinction is between the fixed rate agreed at trade inception and the floating rate realized over the swap period: if cuts are delayed, the floating leg may exceed what was priced into the fixed rate. The material is illustrative and includes a historical meeting example, so its dates and market pricing should not be treated as current. It does not compare the instruments’ costs, liquidity, basis risks, or suitability, and a meeting swap’s payoff depends on its exact dates and reference rate.

Key ideas

  • A view that rates will remain higher than market pricing can be expressed by paying fixed and receiving floating.
  • A meeting-dated overnight-index swap can focus exposure on a particular policy decision period.
  • The trade benefits when the realized floating rate is higher than the rate reflected in the fixed leg.
  • Futures spreads, forward-rate agreement spreads, curve trades, and short-dated swaps are alternatives mentioned.
  • Historical dates and pricing in the example are time-specific, and instrument details affect the payoff.

Tags

Fixed incomeDerivatives pricingRisk management
Full text
# Interest rate swaps - if i expect rates to be cut later than market expectations, what swap can I put on?


# Interest rate swaps - if i expect rates to be cut later than market expectations, what swap can I put on?












- If I think market expectations are too dovish and I expect rates to stay high for longer i.e. rate cuts by X central bank to happen in September for example (as opposed to whats priced in, e.g. May), what type of interest-rate swap would i put on to "benefit" from rates higher for longer?

- I've read that in this case i would want to receive Aug24 (fixed) and pay floating - is this right? Given I'm expecting rates to go down then, however, if I expect rates higher for longer, wouldn't I be making a loss given floating would be higher rates?

Please treat as if explaining to a 5 year old.

## Answer by CurveGamma (score 0)

https://quant.stackexchange.com/a/78837

- The way to trade this is to put on a FOMC swap - where the start and end date is the meeting date, the underlying can be sofr or fedfunds(ff) and the notional can be the pv01 of risk you want to put on - say 100k/01.

Currently the market is pricing in a cumulative 25 bps of cut by June. Lets say you think this is wrong and that a string of strong inflation data will force the Fed to delay cutting rates. The dates of the meetings are here: https://www.federalreserve.gov/monetarypolicy/fomccalendars.htm

- So you enter into a June FOMC swap - start date: is 06/12/2024 and maturity is 07/31/2024 with 100k/01 of notional and you pay fixed and receive the floating (say fed funds (ff)). Now the market expects that the ff will set 25bps lower than its currently setting (https://www.newyorkfed.org/markets/reference-rates/effr) so they will pay you a lower rate in that June FOMC period - BUT if the FOMC doesnt cut rates as per your thesis, you will receive the prevailing higher ff rate and make money on this swap.

3.Do you want to work out how to close this swap to lock in the cash payment the day after the June meeting? hint: the nomenclature is a rundown swap.

- You can also put a second trade on to trade when you think rates will start to be cut as per @Attack68 and @nbbo2.

## Answer by D Stanley (score 0)

https://quant.stackexchange.com/a/79217

If you expect interest rates to "not go down as much" as the market expects, then you would want to pay a fixed rate, which would reflect that rate reduction and receive a floating rate, which would rise more than (or at not go down as much as) the market thinks.

In other words, a fix-for-float swap would be fairly priced with a fixed rate representing market expectations of the changes in the floating rate. If you think the floating rate will not go down as much (or rise), then you'd want to lock in the fixed rate that the market thinks will be lower.

## Answer by Sebastian Correa (score 0)

https://quant.stackexchange.com/a/84058

There are many strategies to benefit from your scenario scenario:

- fed fund futures spread trade.

- fra spread: rec 3m3m-6m3m sofr swap spread.

- similar to point 2, pay 3m6m9m sofr fly. Again if you think 3m is too rich.

- pay 3m ois if you think that the curve is over pricing cuts in the next 3 months.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.