A plain-English guide to OIS.
What overnight-index swaps measure, what they do not, and how to read them against fed-funds futures.
OIS, the overnight-index swap, is the cleanest way the market has of pricing the expected path of the central bank's policy rate. It does one thing well, leaves several things alone, and is often confused with instruments that look similar but mean different things. This is the reference piece on what it is, what it measures, and how to read it.
What an OIS actually is
An overnight-index swap is a contract between two parties. One side pays a fixed rate for the life of the swap, agreed at trade date. The other side pays the geometric average of an overnight benchmark over that same life. At maturity the two streams are netted in cash. No principal changes hands.
The overnight benchmark is the policy-anchored rate of the currency area: the effective federal funds rate (EFFR) in the US, €STR in the euro area, SONIA in the UK, SARON in Switzerland, and so on. Each of those is, on most days, where the central bank's policy stance binds.
What it measures, and what it doesn't
Because the floating leg is the realised overnight rate compounded daily, the fixed leg of a fairly-priced OIS is, by no-arbitrage, the market's expectation of the average overnight rate over the swap's tenor. A 6-month OIS gives you the expected average policy rate over the next six months. A 1-month OIS starting six months forward gives you the expected policy rate during that future month.
Two things it does not measure. It is not the bank-funding rate, which carries credit and term premia on top of the policy path. The OIS-Libor spread (and now OIS-SOFR-spread analogues in some contexts) is the right gauge for funding stress, precisely because it strips out the policy expectations. And OIS is not the same as the Treasury yield of equivalent tenor. The difference, Treasury yield minus OIS, is the closest market measure of the term premium in governments.
OIS vs fed funds futures
Fed funds futures and OIS look like they answer the same question: what does the market price the Fed at in N months? They mostly do, and in practice analysts use them interchangeably for the front part of the curve. There are real differences.
| Property | Fed funds futures | OIS |
|---|---|---|
| Settles on | Monthly average of EFFR | Geometric average of EFFR over swap life |
| Tenors | Calendar months, out about 36 months | Continuous, from 1 week to 30+ years |
| Listed where | CME (exchange-traded) | OTC, bilateral or cleared |
| Best for | Pricing a specific FOMC date | Average expected rate over an arbitrary period |
For "what is priced into the May meeting?" use fed funds futures and take the difference between the months that bracket the FOMC date. For "what is the average expected policy rate over the next twelve months?" use a 1-year OIS quote directly. For "what is the implied rate between December and June?" use the OIS forward curve.
Reading an OIS curve in practice
Most strategists watch three things on the OIS curve:
- The level: the 1-year OIS rate tells you the market's average policy expectation over the next twelve months. A level above the current policy rate prices hikes; below, cuts.
- The shape: the 1-month rate 12 months forward minus the 1-month rate today gives you the implied policy change over the next year. Cleaner than reading a single quote because it isolates the expected change rather than the average.
- The spread to Treasuries: the 10-year Treasury yield minus the 10-year OIS is, definitionally, the term premium plus any specialness in the Treasury market. It moves slowly and is one of the cleaner long-cycle indicators.
One worked example
Suppose the current policy rate is 4.50 percent, the 6-month OIS prints 4.30 percent, and the 12-month OIS prints 4.05 percent. The market is pricing roughly 20 basis points of cuts on average over the next six months, and roughly 45 basis points over the next twelve. That is not "two cuts in twelve months" exactly; it is "the average policy rate over the next twelve months is 45 basis points below today." It matters that an early cut weighs the average more than a late one. If you want the date-specific reading, go to fed funds futures and read off the FOMC steps.
Where OIS shows up in practice
- Pricing floating-rate notes (the discount curve for cleared rates)
- Decomposing nominal Treasury yields into expected rates and term premium
- Building forward rate views without committing to a specific meeting
- Cross-currency basis (OIS in each leg, plus the FX-implied funding spread)