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A guide on how to express your rate hike/cut expectations. The example of the United Kingdom with SONIA futures.
Althea Spinozzi
Head of Fixed Income Strategy
Summary: The bond futures market is pricing nearly 115 basis points rate hikes by the Bank of England from today until February next year. Bond futures enable you to express your rate hike or cut expectations. This article wants to be a guide on how to use them.
Price pressures continue to be a problem in the United Kingdom.
Although headline inflation began to adjust lower, core inflation is picking up again, putting the Bank of England on a much more aggressive trajectory.
However, how much more aggressive the Bank of England can be? According to Bloomberg, markets are betting for the BOE base rate to peak at 6.15% on February 2024, two months after the ECB and Fed benchmark rates peaked.
Such expectations might provide a window of opportunities for those traders that do not believe the BOE will go that high or for those that think it will go even higher.
How to express your rate hike/cut expectations with bond futures?
Bond futures can be useful instruments to express your interest rate hike or cut expectations. In the case of the UK, you’d need to look at the SONIA rate, which reflects the average of the interest rates that banks pay to borrow sterling overnight from other financial institutions and other institutional investors[1].
You can find SONIA future contracts in the Saxo platform by using our screener and selecting "Contract Futures," and filtering by the keyword "SONIA." The screener will return you a list of SONIA future contracts with expiry from today until two years and a half later.
To better understand what we have in front of us, let’s pick the SONIA June 2023 contract (SO3M3). Although it says "June" on the contract, we can see from the trading conditions that it expires on the 19th of September, 2023. The contract is trading with an ask price of 94.82, which reflects a BOE base rate of 5.18% (100 – 94.82). Because the June BOE meeting is concluded already, and the current BOE base rate is set at 5%, it concludes that the contract suggests the markets' expectations for an August rate hike.
Looking at the Sonia futures, we can conclude that markets expect the BOE to hike rates by 100bps by the end of the year. In February next year, the market is pricing only a 15bps rate hike.
Suppose you believe the BOE will not be able to hike rates by that much. With the help of bond future spreads you can express that opinion.
You can find a list of bond future spreads by selecting "Future Strategy" on the screener and searching for the keyword "SONIA."
For example, let's take the spread between the June and the September contracts (SO3M3-U3), which, as we explained above, expire in September and December, respectively. The SO3M3-U3 is trading at 0.74%. It's telling us that the market expects the BOE to raise the base rate by 75bps between September and December this year.
If you do not believe that the BOE will hike rates that much in the last quarter of the year, in that case, you would sell the SO3M3-U3 spread. If you believe there is a risk that the BOE will need to hike rates of more than 75bps in Q4, you will buy the SO3M3-U3.
You can use Saxo’s charts to visualize the spread better. To do that, you need to load the chart for the SO3M3 ticker first, then press the "+" sign on the top left of the chart to add the other contract SO3U3. Finally. Click on the Indicator toolbar on the top right and select "spread." The SO3M3-U3 will appear at the bottom of the chart.
The same can be done for other bond future spreads, not only in the UK but also in the US with the SOFR contract and in Europe with the Euribor.
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