Marketwatch reported last week that there was a 100.2% probability of a Dec Fed hike. Umm… that would be wrong. But the reason I bring this up is that it is not clear what the new FF effective rate (“FFER”) would be after the hike. If Marketwatch thinks the new FFER is going to be 64bps after a hike, their “analysis” could be right. The FFER is currently 41bps, and the “easy” thing to do would be to assume it will be 25bps higher (to 66bps). You could even model the three month-end days in January 2017 to get something closer to 65bps for FFF7 (assuming you are using FFF7 to express your Dec hike view). However, there can be some volatility and we don’t have much of a sample size on what happens to the FFER after a hike – especially near the zero bound.
Last year, the FFER was basically 12bps in November (not including special days), edged up to 13bps at the start of December, and was 15bps the day before the meeting. The FFER was strangely 15bps on the day of the meeting (typically it has been closer to the new FF target rate, rather than the old rate). It shot up to 37bps the following day, and settled around 36bps for about a month thereafter. The increase in FFER after the Dec 2015 hike was not the full 25bps. FFZ6 could be even noisier because it’s not clear what the FFER on Dec 14 is going to be. Will it be closer to the old rate like last year or the new rate as in prior years?
Libor may have even more noise on a surprise skip. EDZ6 fixes a few days after the meeting, and I’m not sure if that is enough time for libor to settle down (there could be more noise). If you are going to play for a Fed skip in Dec (not likely, but you never know), I would stick to FFs. If the Fed hikes, there may be some value in options structures that are short the 99.00 strike, as the EDZ6 90 straddle for 4.25 seems a little high relative to other hike plays.
The point is that there is a lot of noise in taking a view on this particular meeting – I don’t think it makes sense to have a large exposure to the fixings, unless you have a very firm view of how the FFER trades. I’m not sure most people who are not dealers would have a strong edge in this. Futures trading is a zero sum game – if someone else has an edge, you may not. But as always, this is just my two cents.