OIS swap: definition

A rate exchange

In an OIS swap, two parties exchange, over a given period, a fixed rate for the compounded average of an overnight rate: €STR in the euro area, SOFR in the United States, SONIA in the United Kingdom. No principal changes hands; only the interest difference is settled at maturity.

The fixed rate at which the market accepts this exchange is therefore the best estimate, collective and backed by money, of what the overnight rate will average over the period.

Reading central bank expectations

Since the overnight rate closely tracks the policy rate, an OIS covering the period between two meetings says where the market expects the rate after the next decision. If the policy rate is 2.00% and the corresponding OIS trades at 1.90%, the market expects a 10 basis point cut on average.

Measured against the usual 25 point step, this gap gives an implied probability: here roughly a 40% chance of a 25 point cut and 60% of a hold. This is the method used by expectation-tracking tools, including the one on this site.

Its limits

An implied probability isn't a forecast. It contains a small risk premium, and it blends scenarios: 50% can mean a one-in-two chance of a 25 point cut, or a one-in-four chance of a 50 point cut. It remains the best available thermometer of what is already priced in.

Frequently asked questions

What's the difference between OIS and Fed funds futures?

Both measure rate expectations. Fed funds futures are contracts listed in Chicago on the effective fed funds rate; OIS are over-the-counter swaps, available for all the major currencies.

Why OIS rather than the two-year yield?

A bond yield contains a term premium and a credit risk premium. OIS, tied to the overnight rate, isolates monetary policy expectations much better.