(Bloomberg) -- Traders in the US interest-rate options market are still betting on at least one super-sized Federal Reserve interest-rate cut this year — just probably not before the Nov. 5 US election.
Ahead of next week’s central bank policy gathering, Fed swaps reflect expectations for a quarter-point cut, with only a scant possibility for something bigger. Looking out further, it’s a different story.
Recent activity in options linked to the Secured Overnight Financing rate shows that traders are increasingly positioning themselves for roughly 150 basis points of cuts by the central bank’s Jan. 29 policy decision. That’s the same as is currently priced in in by the swaps market.
To implement that amount of easing, officials would, in the absence of an intermeeting move, have to implement cuts of at least half a point at two of the four scheduled gatherings through January — moves that are bigger than the standard quarter point.
Just weeks ago, traders were loading up on bets for a half-point rate cut this month — or even sooner — on worries a deteriorating US labor market would force the Fed to take rapid action against the threat of recession. While data since then has allayed those concerns somewhat, traders are still wagering on the possibility that the central bank will need to make some big moves soon.
Even a quarter-point reduction next week would be a milestone, marking the turning point at which Fed central bankers pivot to monetary easing after more than two years of restrictive rate policy. It will follow three potentially market-moving events this week: the US presidential debate between Vice President Kamala Harris and former President Donald Trump on Tuesday, and readings on US inflation on Wednesday and Thursday.
Already, Treasuries have rallied as traders cemented expectations for imminent Fed rate cuts, sending yields sharply lower.
In the options market, Monday’s session saw a $9 million trade emerge targeting an increase in the amount of Fed easing being priced in by the March 2025 policy meeting, while a $3.5 million “premium play” looked to target at least one half-point Fed move at the September or November policy meetings.
Elsewhere, traders in Treasury futures renewed bullish wagers after covering short positions in the aftermath of a key jobs report on Friday. The bullish setup holds the potential for a reversal, should traders look to lock in profits around next week’s Fed Open Market Committee meeting.
“This remains an environment where longs are vulnerable to profit-taking against a backdrop of cyclically richening as we look towards FOMC,” Citigroup Inc. strategist David Bieber wrote in a Tuesday note.
See more: Waller, Payrolls Trigger Wave of Liquidation in Treasury Futures
Here’s a rundown of the latest positioning indicators across the rates market:
JPMorgan Survey
Investor sentiment continues to build toward a continued bond market rally, with JPMorgan clients extending long positions by 2 percentage points in the week up to Sept. 9, taking investors to the biggest outright long in a month.
Dovish Wagers Adjusted
Dovish hedges continued to build in SOFR options over the past week, with most activity seen across the 97.50 and 98.50 strikes due to flow which appeared to roll-up longs and profit-taking on an existing SOFR Mar25 96.75/97.75 call spread, into a new 97.50/98.50 call spread. Other flows over the week contributing to large swings in open interest included a buyer of the SOFR Sep24 95.3125/95.375 call spread.
SOFR Options Heatmap
In SOFR options out to the March 2025 tenor, call option strikes around a 95-handle remain heavily populated, including a large amount of Sep24 calls which expire Friday, but will still capture Wednesday’s CPI and Thursday’s PPI data. The past few sessions have seen a surge of demand across multiple upside hedges around the September options, both into and out of Friday’s jobs report.
Asset Managers Rebuild Long Positions in Futures
In the week up to Sept. 3 asset managers re-established duration long positions in Treasury futures, following a couple of weeks of heavy de-leveraging and liquidation. On the week asset managers added to net duration long by roughly 66,000 10-year note futures equivalents, while hedge funds added to net duration short by approximately 167,000 10-year futures equivalents.
Options Premium Is Near Neutral
The premium paid to hedge the market continues to hover around neutral over the past week across tenors, after spiking a couple a few weeks ago to favor call premium as traders looked for a continued market rally. Recent standout flows in Treasury options have included an $8 million premium trade targeting 10-year yields around 3.35% by Nov. 22 and a $14 million premium weekly option buyer seen Tuesday, in a bullish trade which expires Friday.
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