If Powell fails to cut interest rates significantly, record bets will face heavy losses

At 2 a.m. Beijing time on Thursday, the Federal Reserve is about to announce its latest interest rate decision. If Fed officials choose to kick off the rate cut with a standard size, the record-breaking bets could lead to significant losses for traders.

Data compiled by institutions shows that trading activity in October federal funds futures used by investors to bet on this week's decision has surged to the highest level comparable since the contracts were introduced in 1988. Most of these new bets are wagering that the Fed will cut rates by 50 basis points.

The data shows a significant increase in related positions this week. Subadra Rajappa, head of U.S. rate strategy at Societe Generale, said, "This puts the market under tremendous selling pressure in the event of a smaller rate cut by the Fed and Powell signaling a gradual approach."

"If the Fed cuts by 25, not 50 basis points, the market reaction will be much stronger," she said. "Claims such as unwinding, optimism, and a more accommodative financial environment may be put to the test."

While the initial consensus last week was that officials would opt for a 25 basis point cut first, recent media reports and comments from former New York Fed President Dudley suggest that decision-makers may easily opt for a more aggressive action, leading to a clear shift in this consensus.

Market-implied odds now show that the probability of a 50 basis point rate cut is slightly higher than 50% before the Fed's decision. Meanwhile, the sharp rise in benchmark U.S. Treasuries yields has led to a significant decline, with the yield on the two-year U.S. Treasury hitting a two-year low of 3.52% this week.

Alyce Andres, U.S. rates/forex strategist, said, "Regardless of how investors react to the Fed's decision, there is no reason to give up further rate cuts, leaving a bias to buy on dips."

Kathy Jones, Chief Fixed Income Strategist at Charles Schwab, said short-term U.S. Treasuries are more sensitive to Fed policy, with the potential for the greatest impact, especially considering that short-term U.S. Treasuries are "already priced quite aggressively." "If it's a 25 basis point cut, as an initial reaction, you could easily see a pullback of 10 or 15 basis points."

"Bond traders are inclined to bet that the Fed will kick off its rate-cutting cycle this week with a 50 basis point move." On Tuesday, after unexpectedly strong August retail sales data indicated increased resilience among U.S. consumers, the market estimated a 55% probability that policymakers would announce a 50 basis point cut. This uncertainty leaves significant uncertainty in financial markets ahead of the Fed's September policy decision.

Blerina Uruci, Chief U.S. Economist at T. Rowe Price, said, "We could get a 50 basis point rate cut, and the Fed's economic forecasts summary may show the dot plot suggesting a total of 100 basis points of rate cuts for the year Bloomberg's return index shows that US Treasury bonds are expected to rise for the fifth consecutive month, setting a record for the best monthly winning streak since 2010. The rise in US Treasury bond prices has pushed yields lower, with almost the entire curve (except for the 20-year bond) trading below 4% on Tuesday.

Macro strategist Simon White stated, "Retail sales in August overall exceeded expectations. This is consistent with strong leading data, but not with the market's expectation that the Fed is very likely to cut rates by 50 basis points this week."

Nevertheless, the swap market still prices in a 76 basis point easing before the November meeting, implying a 50 basis point adjustment in one of the next two decisions. Traders have priced in a 243 basis point rate cut over the next 12 months, which would bring the Fed's policy rate down to 3% if achieved.

Ashok Bhatia, Deputy Co-Chief Investment Officer at Neuberger Berman Group, said, "As the market has already priced in a significant amount of easing, yields could rebound. Based on what we know now, it will be difficult for the Fed to achieve all of this."