Bond traders have been increasing their bets on options and futures, believing that the Federal Reserve is about to signal that the rate cuts next year will be larger than the market expects.
On Thursday morning Beijing time, a 25 basis point rate cut by the Federal Reserve is almost regarded as a foregone conclusion, so the Fed's updated quarterly economic outlook and interest rate predictions will become the focus. In September, the median forecast of Fed officials for their policy path (known as the 'dot plot') showed a total rate cut of a full percentage point over the next two years.
However, as inflation continues to rise, Wall Street banks are beginning to expect that the Federal Reserve may reduce one rate cut next year, totaling a reduction of 75 basis points. Some also predict that the Fed may only cut by 50 basis points, a level that is generally consistent with the pricing in the swap market.
However, in terms of interest rate options, some traders are betting that the market view is too hawkish, with the Federal Reserve being closer to its September forecast: that is, four rate cuts of 25 basis points in 2025, lowering the implied target rate for the Fed funds to 3.375%.
These traders may be considering how potential signs of a weak job market could boost bets on the Fed increasing easing efforts, as well as the significant rise in U.S. Treasury yields earlier this month due to data showing an unexpected rise in unemployment rates.
In options highly sensitive to expectations of Federal Reserve policy, linked to the secured overnight financing rate, demand is mainly focused on dovish bets maturing early next year with a target for early 2026. If the Fed's policy forecast is more dovish than the market expects, these positions will benefit.
Meanwhile, traders are also increasing their positions in Federal Reserve fund futures. Open interest in contracts maturing in February next year has reached a historical record, closely related to the Fed's December and January policy statements. Recently, the funds flowing around these fund futures have leaned towards buying, indicating that new bets will benefit from a Fed rate cut in December, followed by additional easing measures in the next decision on January 29 next year.
Morgan Stanley advised buying Federal Reserve fund contracts maturing in February next year, a suggestion that seems to have spurred bullish activity. Strategists say investors should prepare for a higher likelihood of a 25 basis point rate cut on January 29 next year, as long as the Fed delivers on its commitments this week, the probability of a rate cut next month is about 10%.
Article forwarded from: Jin Ten Data
