The Federal Funds futures market's bets on the scale of the Fed's rate cuts in December and January have significantly expanded, and Morgan Stanley's endorsement has further fueled these bets.
Last Friday, the number of federal funds futures contracts expiring in January and February next year held by traders soared, with prices rising under record trading volumes. Morgan Stanley strategists stated in a report that they recommend buying contracts for February next year.
A group led by Morgan Stanley strategist Matthew Hornbach stated in a report: 'We believe investors should prepare for a higher market implied probability of a 25 basis point rate cut at the Federal Open Market Committee (FOMC) meeting on January 29 next year.'
They wrote that the suggested approach includes buying federal funds futures contracts expiring in February next year to benefit from the overnight index swap rate for the January meeting.
Morgan Stanley's economists expect the Federal Reserve to cut interest rates by 25 basis points in December and January, but investors remain skeptical. The overnight index swap (OIS) market prices the easing at about 20 basis points for the Fed's December 18 decision, indicating an 80% probability of a rate cut. In contrast, this probability was around 64% before the employment data for November released last Friday sparked market bets on a rate cut this month.
Last Friday, the trading volume of federal funds futures contracts betting on January and February rates reached a historical high as buyers flocked in. The trading volume for contracts expiring in January next year reached 410,842, surpassing the approximately 250,000 contracts traded on November 14, when Fed Chairman Powell stated that the recent performance of the U.S. economy was 'very good', providing room for the central bank to lower rates at a cautious pace.
Open interest for contracts expiring in January next year increased by about 7%, exceeding 500,000; open interest for contracts expiring in February next year rose by more than 3%, reaching 318,000, also setting a historical high. Last Friday's trading activity included a block trade of about 20,000 contracts at a price of 95.715. Morgan Stanley's recommendation is to buy at a price of 95.71 or trade at an OIS rate of 4.300%.
The market may price in the Fed's rate cuts in December and January more fully this week, with potential catalysts including the consumer price index (CPI) and producer price index (PPI) reports released on Wednesday and Thursday for November.
Article reposted from: Jinshi Data
