Traders are betting that after the Federal Reserve's 25 basis point cut in September, there will be two more 50 basis point cuts in the near future

Traders in the US interest rate options market are still betting that the Federal Reserve will cut rates significantly at least once this year - just maybe not before the US election on November 5th. Ahead of the Fed policy meeting next week, the options market reflects expectations of a 25 basis point rate cut, with little possibility of a larger rate cut. However, recent options activity related to secured overnight financing rates shows that traders are increasingly preparing for a total rate cut of 150 basis points by January for the Fed.

Ahead of the Fed policy meeting next week, the options market reflects expectations of a 25 basis point rate cut, with a lower likelihood of a larger rate cut. But looking further ahead, the situation changes.

Recent options activity related to secured overnight financing rates shows that traders are increasingly preparing for a total rate cut of 150 basis points by January for the Fed; this is consistent with current pricing in the options market. To implement such a large-scale easing policy, officials will have to cut rates by at least 50 basis points in two out of the four meetings before January next year - a magnitude greater than the standard 25 basis points.

Just a few weeks ago, traders were heavily betting on a 50 basis point rate cut this month (or even earlier) due to concerns that the deterioration of the US labor market would force the Fed to take swift action to address the threat of an economic recession. Although subsequent data has somewhat alleviated these concerns, traders are still betting that the Fed may soon need to take significant measures.

Even a 25 basis point rate cut next week would be a milestone, marking a turning point for the Fed from implementing restrictive rate policies for over two years to monetary easing. This week will see three events that could potentially impact the market: the presidential debate between US Vice President Harris and former President Trump on Tuesday, as well as US inflation data on Wednesday and Thursday.

As traders solidify their expectations of an imminent Fed rate cut, US Treasury prices have risen sharply, leading to a significant decline in yields.

In the options market, Monday's trading saw a $9 million increase in bets on the size of Fed rate cuts by March 2025, while a $3.5 million "premium trade" was aimed at at least one 50 basis point rate cut at the Fed's policy meetings in September or November.

On the other hand, US Treasury futures traders covered short positions after the release of key employment reports last Friday, resuming bullish bets. If traders hope to lock in profits around the upcoming Federal Open Market Committee (FOMC) meeting next week, this bullish trend may see a reversal.

Citigroup strategist David Bieber wrote in a report on Tuesday: "As we await the FOMC meeting, in the backdrop of cyclical strength, bulls remain vulnerable to profit-taking." JPMorgan Survey Shows Increase in Long Positions by Clients

Investors' confidence in the continuous rise of the bond market continues to heat up. In the week ending September 9th, JPMorgan clients expanded their long positions by 2 percentage points, marking the largest direct increase in long positions in a month.

Dovish Betting Adjustments

Dovish hedge funds continued to establish SOFR options in the past week, with most activities seen in the exercise ranges of 97.50 and 98.50. The reason is that fund flows seem to be an extension and profit-taking retreat of the existing 96.75/97.75 call spread strategy for SOFR on March 25th, entering a new 97.50/98.50 call spread strategy. Other fund flows causing significant fluctuations in open interest contracts this week include a buyer of the SOFR September 24th 95.3125/95.375 call spread strategy.

SOFR Options Heatmap

In the SOFR options expiring in March 2025, there is still a large amount of call options around 95 points, including a significant number of call options expiring on Friday, September 24th, but they will still be influenced by Wednesday's CPI and Thursday's PPI data. Over the past few trading days, there has been a surge in multiple upward hedging demands around September options, both before and after the release of the employment report on Friday.

Asset Management Companies Rebuilding Long Positions in Futures

In the week ending September 3rd, after experiencing several weeks of significant deleveraging and liquidation, asset management companies reestablished long-term long positions in US Treasury futures. This week, asset management companies added approximately 66,000 contracts equivalent to 10-year US Treasury futures to their net long positions, while hedge funds added approximately 167,000 contracts equivalent to 10-year US Treasury futures to their net short positions

Option Premium Approaching Neutral

Over the past week, the option premium paid for hedging the market has continued to hover around neutral. A few weeks ago, as traders anticipated a continued market rebound, the option premium soared to bullish levels. Notable performances in recent U.S. Treasury options trading include an $8 million premium trade targeting a 10-year U.S. Treasury yield of around 3.35% by November 22, as well as a $14 million premium option buyer on Tuesday, with the bullish trade expiring on Friday.