Traders begin betting on another half-point Fed hike

Traders began betting on Thursday that the Federal Reserve could raise interest rates again at its next March policy meeting, after an official suggested that at their last meeting he saw arguments.”convincing” for a rise of that magnitude.

Interbank index swaps are now discounting around 29 basis points of adjustment for the March meeting, after Cleveland Fed President Loretta Mester said Thursday she saw a “compelling economic case” for a half-point rate hike at the central bank’s meeting two weeks ago, despite the fact that on that occasion the decision was made to slow down to quarter-point increases.

One transaction highlighted in the wake of Mester’s comments was a $375,000 bet on put options on SOFR guaranteed funding rate futures—which are closely related to the Fed’s benchmark rate—that would generate $9 million in profit if the officials will opt for a half-point increase next month, according to a Bloomberg analysis.

Traders also placed bets on higher interest rate volatility after Mester’s comments, including an $11.5 million straddle position in SOFR options.

The Fed has raised its benchmark rate eight times since March 2022, in a series of hikes that included two half-point hikes and four three-quarter-point hikes.

In the past, the central bank has generally opted for quarter-point hikes, and the shift to smaller increases at this month’s meeting was seen as a return to normalcy after the most aggressive pace of tightening seen since early the 1980s.

But economic data released since the February 1 decision — including a higher-than-expected producer price report released Thursday — has raised the risk of a final rate higher than previously thought, as well as a return to large increases.

Edward Bolingbroke