The bet on the Federal Reserve cutting interest rates by 50 basis points in September has surged!
The bet on a 50 basis point rate cut by the Federal Reserve in September has sharply increased, indicating market expectations for proactive action by policymakers. Many options traders have increased their holdings of call contracts, especially before the FOMC announces interest rates. If the non-farm payroll report and CPI data show economic slowdown, it will support the reasons for the Fed to ease policy faster. The current market expects a one-third chance of a rate cut. Economists believe that although the U.S. economy is still growing, the necessity of a rate cut is not obvious. However, the cautious market response and the betting frenzy triggered by Powell's speech have once again made this topic a focus
Interest rate options traders have increased their bets on a 50 basis point rate cut by the Federal Reserve this month, reflecting a growing market speculation that policymakers will take aggressive action to prevent the economy from falling into distress.
Options linked to the Secured Overnight Financing Rate (SOFR) show a significant surge in open interest (the number of positions held by traders) in some call contracts expiring on September 13, five days before the FOMC issues its rate statement. If this Friday's nonfarm payrolls report and next week's Consumer Price Index (CPI) data indicate a cooling job market and inflation, there will be enough evidence to prove that the Fed has reason to ease policy more quickly, resulting in profits for these positions.
Currently, swap contracts indicate a one-third probability of a 50 basis point rate cut by the Fed this month. Priya Misra, portfolio manager at J.P. Morgan Asset Management, said, "The labor market has slowed down and is now catching the Fed's attention. Considering the current federal funds rate is between 5.25-5.5%, the economy is slowing down, and the lag between monetary policy and the economy is notoriously long and variable. I think there is a strong case for an initial 50 basis point rate cut."
The bond market has recently rebounded strongly, pushing the yield on the 10-year U.S. Treasury back to last month's lows when unexpected weakness in job growth raised concerns about the U.S. sliding into a recession. J.P. Morgan's survey found that clients have increased bullish bets on U.S. Treasuries and reduced short positions.
Economists expect that the data to be released on Friday will show a slight rebound in August nonfarm payrolls creation to around 165,000, enough to lower the unemployment rate but still far from the robust growth earlier this year. During the COVID-19 pandemic, the credit crisis, and the bursting of the dot-com bubble leading to a stock market crash, the Fed has cut rates by 50 basis points or more. However, the necessity of such hasty action now seems less apparent as the U.S. economy continues to grow, and the stock market remains not far from its peak this year. But after Fed Chair Powell's speech at Jackson Hole, options trading betting on this move has heated up, with some believing his speech has paved the way for such action.
Traders have had experiences of losses recently due to betting on the Fed's path, so many remain cautious of this risk. For example, at the end of 2023, the market rebounded strongly as it expected the Fed to start cutting rates early in the year, but when the economy showed remarkably strong performance, the market gains evaporated.
Jonathan Cohn, head of the U.S. Rates Strategy at Nomura Securities International, said, " There is a divergence in the market on whether the first rate cut in September will be 25 basis points or 50 basis points. This almost entirely depends on the results of the employment report. If certain thresholds are reached in terms of unemployment and layoffs, then 50 basis points is definitely worth considering." Neil Dutta from Renaissance Macro Research said, "The market seems to view the September rate cut as a coin toss between 25 and 50 basis points. I believe the risk of a 25 basis point cut is the same as skipping the July meeting. If the next data point causes investors to rethink the Fed's decision, it will exacerbate bets that the Fed is behind the curve. You should cut rates by 50 basis points when you can, not when you have to."