Determining % chance of different Rate Hikes

Saw a tweet yesterday that said "The market has priced in a 100bps hike at a 25% chance".

How does one go about determining the % chance of different rate hikes being priced in? 

Thanks 

Comments (12)

2mo
JamieDiamondHands, what's your opinion? Comment below:

Look at the price of an option of 10 year gvmt bonds

The price of the short is determined by two factors (a) pay-off and (b) prob. Of pay-off.

You know the pay-off so can work backwards from the price of the short and estimate the markets expected prob. of the short being in the money.

I m not sure tbh because I m in healthcare but given no one else has answered thought I d shoot

2mo
HFPM, what's your opinion? Comment below:

To be analytically correct, you should be looking at OIS swap spreads and/or fed funds futures. You can then use that pricing to assess probability. 
 

for example, if SOFR is 2% and the OIS swap spread through next week is 2.83%, then 3+ hikes are priced for next week. And the market is saying there is a 68% chance of 75bps and 32% of 4 hikes (because 2.83 is 32% of the way from 2.75% to 3.00%). 
 

Most Helpful
  • Investment Analyst in HF - Event
2mo

Good comment. Indeed this is effectively the methodology used in the CME FedWatch tool linked above (https://www.cmegroup.com/education/demos-and-tutorials/fed-funds-futures-probability-tree-calculator.html) with a few variations (i.e., take the difference in fed funds futures, interpolate values as two nearest hikes).

The wrinkle (a friendly amendment!) that I would add is that it imperfectly captures real policy uncertainty, limiting the range of outcomes necessarily to at most two adjacent hikes.

Imagine, in your hypothetical, that the relevant difference was exactly 75bps -> the linear method makes it impossible to distinguish between "the fed is hiking 75bps for sure" and "the fed is 80% likely to hike 75bps, but 10% likely to hike 100bps (a la, e.g., Larry Summers), and 10% likely to hike 50bps (a la, e.g., Jeffrey Gundlach or Joe Stiglitz)" - so we shouldn't take the simple futures-based-probability model too seriously. Indeed, it is clearly not "analytically correct" taken literally. (To be clear, even at 83bps, it could be pricing some (small) probability of a 50bps hike.)

While it may be the case that, in this particular example applied today, following the elevated CPI print, we can safely rule out the 50bps hike case and conclude that it is either 3 or 4 hikes, as recently as Tuesday that was likely not true: we could have in good faith assigned probability mass to both 2 and 4 hike cases. 

  • PM in HF - Other
2mo

When you say 3+ and 4 hikes do you mean 1 hike = 25bps?

To get to 68% did you back in to that via 32% between 275 and 300?

Thanks.

2mo
HFPM, what's your opinion? Comment below:

When you say 3+ and 4 hikes do you mean 1 hike = 25bps?

To get to 68% did you back in to that via 32% between 275 and 300?

Thanks.

Yes. A hike is 25bps. And yes - if you assume there are only two options in my hypothetical, then you arrive at 68/32 by finding the weightings that arrive at a weighted average of 2.83%. 

  • PM in HF - Other
2mo

Qui numquam quia et. Autem numquam quia repudiandae quos.

Aut animi molestiae nesciunt quaerat. Et laborum labore architecto quisquam quos. Et earum necessitatibus et quo non magni ab. Cupiditate eos rerum earum doloremque eius neque qui.

Est autem et sit debitis tempora voluptatem. Velit cumque iusto aut non ipsum accusamus. Sit minima qui laboriosam qui. Sit vel officiis eveniet. Cumque aspernatur ut sed nostrum aut id. Voluptate aut dolore qui cumque in beatae. Impedit quas at non sed aliquam ipsam soluta sit.

Start Discussion

Popular Content See all

Why do people invest in hedge funds?
+101HFby curiousandcurious22
HF Analyst Life
+31HFby Analyst 1 in IB-M&A
MM vs Lone Pine/Tiger
+25HFby Research Associate in HF - EquityHedge
Glass Ceiling for Internationals?
+20HFby Intern in PropTrad
MM Mkt Neutral - External funds under the umbrella?
+17HFby Investment Analyst in HF - Other
Best L/S credit funds in London?
+15HFby Associate 3 in PE - LBOs

Career Advancement Opportunities

December 2022 Hedge Fund

  • Point72 98.9%
  • D.E. Shaw 97.9%
  • AQR Capital Management 96.8%
  • Citadel Investment Group 95.8%
  • Two Sigma Investments 94.7%

Overall Employee Satisfaction

December 2022 Hedge Fund

  • D.E. Shaw 98.9%
  • Magnetar Capital 97.8%
  • Blackstone Group 96.8%
  • Citadel Investment Group 95.7%
  • Millennium Partners 94.6%

Professional Growth Opportunities

December 2022 Hedge Fund

  • D.E. Shaw 99.0%
  • Point72 97.9%
  • AQR Capital Management 96.9%
  • Citadel Investment Group 95.8%
  • Blackstone Group 94.8%

Total Avg Compensation

December 2022 Hedge Fund

  • Portfolio Manager (9) $1,648
  • Vice President (22) $464
  • Director/MD (11) $434
  • NA (5) $306
  • Manager (4) $282
  • 3rd+ Year Associate (23) $275
  • Engineer/Quant (63) $269
  • 2nd Year Associate (29) $251
  • 1st Year Associate (71) $192
  • Analysts (213) $178
  • Intern/Summer Associate (20) $130
  • Junior Trader (5) $102
  • Intern/Summer Analyst (236) $85