Regardless of how much the Federal Reserve will cut interest rates next week, the interest rate market seems to be locking in one thing over the past few weeks: the Federal Reserve will usher in two large waves of interest rate cuts by at least the end of January next year.
According to data from the interest rate swap market, industry traders have fully digested the Fed's expectations of a rate cut next week - but there is only a small probability (less than 30%) that the rate will be cut by 50 basis points. However, looking ahead, the situation is different.
Recent activity in options tied to the secured overnight financing rate (SOFR) shows traders are increasingly positioning for the Fed to cut interest rates by 150 basis points after its January meeting, which is what swaps markets are currently pricing in.
To achieve such a scale of easing, Fed officials would have to implement a sharp 50 basis point rate cut in at least two of the four meetings before the end of January, absent an emergency rate cut between meetings.
In fact, just a few weeks ago, traders were betting that the Fed would cut interest rates by 50 basis points this month amid concerns that a deteriorating U.S. labor market would force the Fed to act quickly to address the threat of a recession.
While subsequent data has eased this aggressive dovish bet to some extent, many traders still expect that the Fed may need to take some "big actions" soon.
In a sense, even if the interest rate is only cut by 25 basis points next week, it will actually be a milestone for the Federal Reserve, marking that after more than two years of restrictive interest rate policies, the Fed's decision makers have finally reached the turning point of turning to loose monetary policy.
In financial markets, U.S. Treasuries have continued to rebound recently, with yields falling sharply, as traders continue to consolidate their expectations of an imminent interest rate cut by the Federal Reserve.
In the options market, a $9 million transaction appeared on Monday, aimed at increasing bets on the scale of the Fed's interest rate cuts by March 2025. Another $3.5 million "premium transaction" targeted at least one 50 basis point rate cut by the Fed at its September or November policy meeting.
Traders in the Treasury futures market are also starting to cover short positions and resume bullish bets after the release of the non-farm payrolls report last Friday. However, if traders want to lock in profits around the Federal Reserve's interest rate meeting next week, the bullish setup may still be reversed.
“As we look ahead to the FOMC, this remains an environment where longs are vulnerable to profit-taking,” Citigroup strategist David Bieber wrote in a note Tuesday.
