Investors in the US interest rate option pay premiums for trade that will produce results if there is a dramatic decline in interest rates, shows that the derivative market gives prices in a sharper slowdown than those anticipated in the largest economy in the world.
This situation is a big turnover from before the inauguration of US President Donald Trump when traders in what the so -called “swaption” is positioned to knock more from the federal reserve because the planned tariff and the expectations of the incoming government that it will increase fiscal expenditure.
Transactional Swaption volume, which is an option to the interest rate swap, nearly $ 700 billion in the end of February, commodity futures trading commission data shows. The underlying assets, exchange rates, measure the cost of exchanging cash flows with fixed interest rates at floating rates, and vice versa. Exchange is used by investors to protect the value of interest rates, including exposure to treasury securities.
Market players said there had been an increase in demand for “recipient swaption,” where investors received permanent feet from the exchange while paying floating rates. The rewards will come when interest rates fall when Fed tries to stimulate the slowing economy by relieving monetary policy.
The recipient, as referred, usually reflects the terrible economic prospects, and is the opposite of the “payer,” a scenario where investors buy the right to pay fixed tariffs and receive floating. Demand for payer swaption rises when the economy is strong and The Fed raises interest rates to slow down.
Guneet Dhingra, head of the US tariff strategy at BNP Paribas in New York, said the option market set a higher probability than a drastic decline in interest rates, even though that did not mean it would happen.
“The probability of the tail risk has increased since Silicon Valley Bank fell in 2023. The risk has become higher in recent weeks,” Dhingra said, referring to a rare event that shook the market.
Trump’s policy on joint tariffs with the deduction of federal government work that sweeps under the Department of Government Efficiency Elon Musk (DOGE) has increased the prospects of rigors of US landing. Market participants are worried that tariffs can increase prices for business and consumers, lift inflation, and damage overall confidence, thwart economic growth.
Trump over the weekend refused to put aside that his trade policy would lead to a recession, but clarified on Tuesday that he did not see one happening.
Minister of Finance Scott Besent, on the other hand, said last week that the US economy can slow down because it switches from public expenditure to more personal expenditure, calling it a “detoxification period.”
Extreme scenario
Analysts say prices to protect against extreme scenarios such as a decline in 100 basis points (BP) in the SWAP level in the near future have increased in the swapstes market.
The shift shows that market players are preparing the worst. The sharp decline in swap rates can only be triggered by a large decline in the level of federal funds, currently at 4.33%, when the US central bank is carrying out a sharp policy easing.
The cost of protecting against 100-BP plunges in one-year exchange rate at the end of six months, for example, has jumped to 40.24 bps (USD6MX1YN3 = R) on Thursday, up from 32.30 bps on February 20, when it fell to the lowest reading since mid-December. The one -year swap level is 4.036% on Thursday (USDSROIS1Y = TWEB).
Although no one estimates a decrease in the near future period of 100-BP in a one-year exchange rate or Fed Fund level, Dinghra BNP notes that the option market always takes into account the worst results.
“The option market shows signs of economic slowdown, but it is not a recession that causes the Fed to cut hundreds of basis points,” said Amrut Nashikkar, Director of Permanent Revenue Strategy at Barclays in New York.
But he showed that there were indeed investors positioned to reach 100 to 150 bps in the level of one year exchange for a period of one year.
When the cost of short -term protection against a large decline in growing tariffs, volatility is implied, key input in option prices, also rises. The higher the volatility, the greater the uncertainty during a certain period.
The price of volatility implied one month option at a one -year exchange rate (USDSR1MX1ATM = R) has risen to the highest level of four months 23.8 bps on Monday, and finally at 20.36 bps.
The increase in implicit volatility is not surprising given the exogenous risk of tariffs, including persistent geopolitical headwinds, said Srini Ramaswamy, director of the executive and head of the derivative strategy at JP Morgan in San Francisco.
“Macro markets and economics find themselves in superpositions between tariff and tariff countries, which created considerable uncertainty and the possibility of contributing to an increase in risk premiums,” which resulted in intraday volatility creeping to the highest level in the last six months, said Ramaswamy.
Source: Ing
