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A step ahead on interest rate risk

Andrew Hollins
Andrew Hollins
Director of FX and Corporate Treasury Desktop at Refinitiv

Managing interest rate risk was a challenge even before the unprecedented response of central banks to the COVID-19 pandemic. How does the Refinitiv Interest Rate Probability app provide reliable insight on the future direction and timing of monetary policy changes?


  1. Refinitiv’s Interest Rate Probability (IRPR) app provides reliable insight into the future direction and timing of central bank interest rate moves for 18 countries across the globe.
  2. The IRPR displays a probability distribution table containing all possible future values for the Target rate at each meeting date.
  3. Calculating probabilities based on expected effective rates has a good record for reliably predicting changes in central bank policy and managing interest rate risk.

Governments and central banks have responded to the COVID-19 pandemic with emergency measures including the dramatic lowering of headline interest rates.

In unprecedented developments, the Federal Reserve unexpectedly cut its Target Rate twice, both times outside the usual cycle of Federal Open Market Committee (FOMC) meetings.

At some point global central banks will begin normalizing their monetary policy. Predicting the timing of this process and managing interest rate risk will be one of the many challenges traders, investors and corporate treasurers must grapple with when they consider positioning their portfolios and their risk management approach.

A deep and sharp recession is widely predicted, but less clear is what a recovery will look like. Will there be a strong inflationary rebound or depression and deflation? Which regions will recover most quickly and which will lag?

Interest rate probability

The Refinitiv Interest Rate Probability app (IRPR) provides insight into the likelihood, timing and magnitude of changes to central bank policy rates at future central bank meeting dates.

This insight is presented as the probability of a particular policy rate — say the Fed Funds Target rate — either staying the same or being cut/raised by a given amount.

IRPR calculates probabilities for 18 global central banks. Each bank we cover pursues a monetary policy regime based on a policy rate which can be changed at periodic meetings, the dates of which are published in advance.

Transparent market data

Of critical importance is the availability of an interest rate term structure built from instruments which exhibit high levels of market liquidity and transparency. In most cases we use Overnight Index Swaps (OIS) but for the U.S. we use the Fed Funds Futures.

Both settle against an index of the effective overnight rate in their respective markets, which is the rate directly influenced by central bank monetary policy via changes to the Target rate.

The effective overnight rate for any given day is the weighted average of that day’s activity in the uncollateralized overnight lending market. For instance, EONIA reflects the weighted average rate for unsecured lending in the overnight euro lending market.

Robust methodology

Term structures for overnight rates in jurisdictions with this type of monetary policy regime generally display a stepped pattern — meaning rates remain constant from one central bank meeting to the next.

This is because prices of derivatives indexed against overnight rates are an efficient reflection of expected future values of central bank rates which themselves (normally) remain constant from one meeting to the next.

We can verify the existence of this stepped structure by referencing historical data for these rates. Below we see the Effective and Target Rates for both the U.S. and the UK.

UK Effective Rate vs UK Target Base Rate. A step ahead on interest rate risk
UK Effective Rate vs UK Target Base Rate
US Fed Funds Effective Rate vs Fed Funds Target Rate. A step ahead on interest rate risk
U.S. Fed Funds Effective Rate vs Fed Funds Target Rate

Generating this stepped term structure from observed market rates is critical when it comes to calculating probabilities. This is because overnight rates are explicitly related to central bank policy rates.

This relation exists since any changes to central bank rates are generally matched by a corresponding market response in the form of a change to the effective rate.

This makes sense because if the effective rate diverges from the desired policy rate, there is a risk the central bank might intervene to re-align the effective rate with the target rate.

Fed Funds Futures and OIS

Using an OIS-derived zero curve, a robust term structure can be created by calculating a series of spot-starting OIS with maturity dates being each central bank meeting date.

A series of forward starting OIS rates is then calculated between each of the meeting dates thus giving us our steps. This approach avoids distortions in cases when meeting dates occur just before maturity dates of standard OIS tenors.

The process using Fed Funds futures is slightly different but achieves the same result. Most contracts contain an FOMC meeting date and, for those, we calculate the weighted average of the pre-meeting and post-meeting expected rates.

Some contracts do not contain an FOMC meeting. These meeting-free contracts allow us to observe fully the expected forward overnight rate between two meeting dates and provide the post-meeting rate for the previous meeting as well as the pre-meeting rate for the next one.

Change from the status quo

In the event of a cut or hike to a central target rate, we assume the change will be of a known magnitude – for example 25 bps or 50 bps depending on the bank.

This assumption is based on observations of previous decisions as well as published policy statements. There is also a constraint which limits the possible outcomes at each meeting date to two: the status quo and either a cut OR a hike. Possible outcomes are clearly signposted in IRPR.

IRPR Federal Reserve Screen
IRPR Federal Reserve Screen

Once we have the implied rate for each meeting date, we can calculate the probability of the rate remaining the same or there being a change — up or down — following the meeting.

Each probability calculation involves determining the direction (either up or down) and magnitude (in basis points) of any change as well as the probability of a change from the status quo taking place.

As well as the likely outcomes for the first meeting date, IRPR displays a probability distribution table containing all possible future values for the target rate at each meeting date. The probabilities at each meeting date or node are determined by summing the probabilities of both paths leading to that node.

Probability Distribution Table. A step ahead on interest rate risk
Probability Distribution Table

Managing interest rate risk

In the majority of cases, calculating probabilities based on expected effective rates has a good record for reliably predicting changes in central bank policy rates. The below chart shows the implied expected and the actual Fed Funds rate over the last five years.

Implied Fed Funds vs Actual Fed Funds Mar 2015 to Mar 2020
Implied Fed Funds vs Actual Fed Funds Mar 2015 to Mar 2020

Refinitiv’s Interest Rate Probability app provides reliable insight into the future direction and timing of central bank interest rate moves for 18 countries across the globe.

Access the app by typing IRPR into Eikon Search. The overview screen summarizes the 18 supported central banks with a dedicated screen providing in-depth analysis for each. Don’t have Eikon? Register for a free trial.