Central banking is challenging at the best of times. Seen in the narrowest sense, the ability of a group of economists to reconcile a complex economic system through inflation targeting has raised many questions. This dynamic does not consider the uniqueness of recent times. Inflation across the OECD has proven difficult, ever since the post pandemic unlocking collided with inflation shocks, where supply chain bottlenecks and geopolitical tensions were exposed.

Today, asynchronous economic performance and consequent monetary policy responses are resulting in a period of divergence, posing a dilemma for those managing interest rate risk. While the Fed led global central banks in rate hikes since early 2022, European monetary policymakers are now diverging from the world’s largest economy - illustrating their willingness to serve domestic mandates.

In the U.S. a combination of stubborn inflation and solid economic growth saw the Fed signal in May that rates would likely stay higher for longer: expectations for cuts were scaled back to just one for 2024 (with 50% chance of two 25 basis point cuts) down from ~6 back in January. By contrast in the U.K, the Bank of England (BoE) signaled that rates would likely be cut in summer if inflation remained low. Other European banks are already loosening policy: Sweden’s central bank cut rates for the first time in eight years in May, following similar moves by the Swiss, Czech and Hungarian central banks. Now, all eyes are on the European Central Bank’s June meeting, where a cut is widely expected.

These dynamics have spurred the return of multicurrency precision where SONIA futures & options are setting new record highs. ICE SONIA derivatives had a record month in April, with 16.5 million contracts traded, and record average daily volume of over 783,000 contracts. Open interest, a key liquidity metric, is up over 200% year-over-year at 7.5 million contracts across the SONIA complex. For those seeking a precise way to express a view on monetary policy, SONIA remains an attractive contract.

Lloyds Bank Corporate Markets Head of Rates Options Trading Tim Woods says, “We’ve seen a sharp increase in client interest in SONIA futures and options in response to diverging views around the path for UK rates. Robust liquidity in the SONIA stack is leading to enhanced pricing in options, which is attracting a significant increase in trading activity."

Globally, ICE has positioned its interest rates business as a multi-currency offering through Euribor, SARON, SOFR and SONIA, noting that the post zero interest rate policy years would likely see the return of monetary policy divergence.

Following the BoE’s May meeting, markets are pricing in a 60% chance of a cut in June, with two 25 basis point cuts fully priced in between August and November. This dynamic takes place against a backdrop where the U.K. will see some of the weakest economic growth and highest inflation this year among G7 advanced economies - including Canada, France, Italy, Japan, Germany and the United States - according to OECD forecasts.

The graph below shows ICE’s combined futures and options SONIA open interest continues to increase over the last three quarters, illustrating the strength of the complex and market interest in managing sterling rate risk exposure.

Average daily volume in ICE’s SONIA complex is 686,874 representing a 67% increase year-to-date vs 2023 and highlighting growing participation from a wider range of market participants.

Are central banks looking at a “new norm” levelling rate? What will rate divergence mean for portfolio risk management?

As we enter the next wave, ICE sees a liquid multi-currency offering can best serve the needs of its customers.

The “SONIA” mark is used under licence from the Bank of England (the benchmark administrator of SONIA), and the use of such mark does not imply or express any approval or endorsement by the Bank of England. “Bank of England” and “SONIA” are registered trade marks of the Bank of England.”