Aggressive Rate Cut Bets Sweep Financial Markets!

Interest rate options traders have recently increased their bets on the Federal Reserve's impending 50 basis point rate cut this month, reflecting growing speculation that Fed policymakers will take aggressive rate-cutting action to prevent a further slowdown in the U.S. economy. Options trading linked to the overnight secured financing rate (SOFR) showed that in the five days before the announcement of the Fed's policy meeting, that is, September 13 expiration of many call contracts, the number of open contracts or positions held by traders surged, reflecting a growing number of traders with real money bets that the Fed will cut interest rates by 50 basis points to boost the U.S. weak labor market as well as economic growth.

If Friday's non-farm payrolls data report and next week's consumer price index (i.e., CPI data) numbers show the U.S. labour market and inflation cooling enough to justify more rapid easing, then these traders dovish betting position will be rewarded. Currently, swaps indicate that the likelihood of the Fed cutting rates by 50 basis points this month is about one-third.

‘The labour market has slowed significantly and is now getting the Fed's attention.’ Priya Misra, a portfolio manager from JP Morgan's asset management division, said. ‘Given that the federal funds rate is 5.25-5.5 per cent, the economy is slowing down and the lag time between monetary policy and the economy is known to be long and variable, I think a 50 basis point cut is very likely.’

Options pile up - the number of open options contracts surges despite flat price action

A strong rebound in the bond market has pushed 10-year US Treasury yields back to last month's lows, when unexpectedly weak US non-farm payrolls growth and a more-than-expected uptick in the unemployment rate sparked fears that the US is heading for a recession. A new survey by JPMorgan Chase found that clients increased bullish bets on the U.S. Treasury market and cut short positions.

Economists are widely predicting that Friday's non-farm payroll data will show a slight rebound in the number of new jobs created in August to about 165,000, enough to lower the unemployment rate, but still nowhere near the strong pace of growth seen earlier this year.

In the wake of the new crown outbreak, the credit crisis and the bursting of the Internet bubble, the Fed had cut interest rates by 50 basis points or more in one go to boost the economy. However, with the economy still growing and stock prices not far below this year's peak levels even after the recent drop, the Fed's need for such a hasty rate cut now seems less clear.

But options trading betting on such a move accelerated after Fed Chairman Jerome Powell's dovish speech at the annual global central bank meeting in Jackson Hole, when some thought his remarks left the door open for such a move. Powell himself in less than 20 minutes of the speech, can be said to publish the Fed's official for the most clear signals for rate cuts, not only formally mentioned that ‘the time for monetary policy adjustments has come,’ suggesting that the Fed's interest rate reduction cycle is coming, but also through a variety of wording suggests that the main work of the Fed's future not only to avoid recession, but also to ensure that the Economic soft landing.

It goes without saying that traders have a recent history of suffering losses from aggressive bets on the path of Fed rate cuts, so many remain aware of the risks. For example, at the end of 2023, the bond market rallied strongly on expectations that the Fed's rate-cutting cycle would begin early this year and that cuts could be as high as 150 basis points, but for a time those gains were all but wiped out when the U.S. economy showed surprising strength.

‘Overall, the market is sharply divided on whether the first rate cut will be 25 basis points or 50 basis points in September.’ Jonathan Cohen, head of US interest rate strategy at Nomura Securities International, said. ‘It depends almost entirely on the job market data,’ ‘If unemployment and layoffs hit certain thresholds, then a 50 basis point rate cut is definitely feasible.’

Here's an overall overview of the latest position indicators in the interest rate market:

JP Morgan Survey

The latest JP Morgan survey data shows that an increase in long positions and a decrease in short positions in US Treasuries increased the net long position of JP Morgan clients by 7 percentage points in the week ending 3 September.

J.P. Morgan Treasury All-Client Position Survey - Client outright longs rise to highest level since last December

The outright long position jumped to its highest level in a fortnight, and all of this Treasury betting data reflects JPMorgan's Treasury clients' warming bets on a Fed rate cut, betting heavily that the Fed could cut rates by 100 basis points this year - i.e., one of the September-December meetings is expected to announce a 50-basis-point cut in interest rates.

More and more traders are aiming for the first rate cut of 50 basis points

Weekly volatility in options open interest continues to be driven by the accumulation of multiple September calls that will benefit from a 50 basis point Fed rate cut at the 18 September policy meeting. On Tuesday, this momentum continued as familiar call option spread structures and condor structures were bought, while open positions showed as new risk.

Most Active SOFR Option Strikes - Top 5 & Bottom 5 Weekly Net Change in SOFR Option Strikes

Based on the structure of the market bets, particularly the large number of call option positions concentrated in the 95-95.5 point range, it is clear that traders are betting on a significant downward trend in interest rates going forward. These positions suggest that traders expect a 50 basis point rate cut by the September 2024 Fed meeting to be increasingly likely.

This expectation is further supported by the buying of the ‘call spread’ and ‘condor’ structures mentioned above. These structures are often used for risk management in anticipation of large market changes, especially in anticipation of large interest rate cuts, and can provide investors with potential profit opportunities in the event of a decline in interest rates.

SOFR Options Heat Map

In SOFR options expiring prior to March 2025, call option points are holding around 95 due to the upcoming non-farm payrolls and unemployment data on Friday, next week's CPI data, and potential risk events ahead of the Fed meeting. Demand for multiple upside hedges around September options has spiked significantly over the past few sessions, implying that aggressive 50 basis point rate cut bets are heating up.

SOFR Options Open Positions - Top 20 Open Positions in SOFR Options as of March 2025 Maturity

The chart above provides a distribution of open positions in SOFR options, showing the overall open interest in options for different expiration months. As you can see from the chart, the vast majority of open positions are concentrated around the strike price of 95 to 95.5, which is the strike price range for betting on a 50 bps Fed rate cut, and is an indirect reflection of a 50 bps future rate cut. This means that if the Fed adopts an aggressive easing policy of cutting rates by as much as 50 basis points or more, these call options will become very valuable.

These SOFR options data show that the market is actively preparing for a potentially aggressive rate cut by the Federal Reserve - i.e. a 50 basis point cut in September. The change and concentration of open positions suggests that investors have a strong expectation of lower interest rates and are strategically positioning themselves through the options market accordingly.

Position volatility in the futures market

Statistics from the U.S. Commodity Futures Trading Commission (CFCT) show substantial position changes in U.S. Treasury futures for asset managers and leveraged hedge fund firms in the week ending 27 August. Asset management firms tacitly continued to unwind long net duration positions, liquidating the equivalent of about 435,000 10-year U.S. Treasury futures contract equivalents. Leveraged hedge funds took a different trading approach, covering about 670,000 10-year U.S. Treasury futures contracts in net short positions across the strip.

Risk appetite returns to neutral

After a high percentage of call premiums a few weeks ago as traders sought a sustained rise in the market, premiums paid to hedge market risk have remained close to neutral over the past week. Recent trading in Treasury options saw one buyer purchase put on 10-year Treasuries with a target yield of around 4% by 20 September, paying up to $7 million in option premiums to do so.

This implies that this buyer expects bond prices to fall (i.e., yields to rise) and is therefore interested in put option premiums. If the buyer believes that the 10-year Treasury yield will rise to 4%, it implies that the buyer has a completely different expectation of US inflation data, economic performance or Fed policy compared to traders betting on a 50 basis point rate cut. This buyer's behaviour seems to be more of a bet that the Fed will not make aggressive rate cuts, or that market expectations of future rate cuts will weaken, or even that the Fed may keep rates higher for a long time.