Traders ramp up wagers on outsized Fed cuts, signalling rising uncertainty in rates and inflation
Traders are increasingly betting on an aggressive path for US interest rate cuts, with options activity signalling expectations for at least one outsized move by the Federal Reserve before year-end, according to Bloomberg.
Recent surges in open interest for December Secured Overnight Financing Rate (SOFR) options reflect a market bracing for a possible half-point reduction at either the upcoming or December policy meeting—more than the two quarter-point cuts currently priced into swaps.
This positioning comes as renewed US-China trade tensions and a prolonged government shutdown have clouded the economic outlook and delayed key employment and inflation data.
Economists surveyed by Reuters also anticipate the Fed will lower its key rate by 25 basis points next week and again in December, with 115 out of 117 polled forecasting a cut to 3.75 percent-4 percent at the October 29 meeting.
However, only 71 percent expect another cut in December, highlighting persistent uncertainty. The poll further reveals economists are deeply divided on where rates will stand by the end of next year, with predictions ranging from 2.25 percent-2.5 percent to 3.75 percent-4 percent.
This division is exacerbated by speculation over who will succeed Jerome Powell as Fed chair when his term ends in May.
The Federal Open Market Committee remains split, with some members, including Chair Powell, prioritizing the labour market, while others focus on inflation risks, noted Ryan Wang, US economist at HSBC.
Private-sector data suggest layoffs and hiring remain modest, and the US unemployment rate is expected to average around 4.3 percent through 2027. Meanwhile, inflation is projected to stay above the Fed’s 2 percent target for the same period, as per Reuters.
Market sentiment is also reflected in the cash market, where two-year Treasury yields have dropped to their lowest levels of the year near 3.5 percent.
According to John Madziyire, a portfolio manager at Vanguard, “you do want to have that bias to be slightly long,” given the current balance of risks, reported by Bloomberg.
As the Fed weighs its next moves, a majority of economists in the Reuters poll warn that the greater risk is policy rates falling too low by the end of the cycle.
This concern is amplified by ongoing political pressure for deeper cuts and the risk of the central bank’s independence being compromised, as highlighted by Brett Ryan, senior US economist at Deutsche Bank.
