What strategy should be employed if interest rates are expected to decline?

When interest rates are expected to decline, holding long positions in futures and options is an appropriate strategy. By going long on interest rate futures, an investor benefits from the price appreciation of the futures as interest rates fall. As market interest rates decrease, the value of these futures contracts rises, allowing for capital gains.

Additionally, purchasing long interest rate options provides the holder the right, but not the obligation, to benefit from favorable movements in interest rates. If rates decline, the value of the long call options on interest rates increases, enabling the investor to capitalize on the downward movement effectively.

This approach advantages from the relationship between interest rates and the prices of both futures and options: as rates decline, asset valuations tend to increase, leading to potential profits for the investor.

It's important to note that strategies such as short futures or short interest rate options would lead to losses in a declining interest rate environment, which would not be beneficial. Similarly, adopting a strategy to buy a swap and pay fixed while receiving floating is also inverse to the expectations of declining rates, as it could lead to losses instead of captures of potential benefits. Finally, decreasing duration generally protects against rising interest rates, which does not align with the expected decline in rates.