Where will the Federal Reserve go next? Traders join the "big bet" on rate cuts in November

According to the Zhitong Finance and Economics APP, the debate surrounding the expected rate cut by the Federal Reserve in November is intensifying. As officials begin to consider the Fed's next move, traders are increasing their futures bets related to the Fed's policy path.

After the release of weaker-than-expected US consumer confidence data on Tuesday, investors are more inclined to see a direct 50 basis point rate cut at the November 7th meeting. This has essentially turned into a coin toss between another significant cut and a more standard 25 basis point cut for the futures market.

Derivatives traders currently expect a total rate cut of about 75 basis points from the Fed for the remaining two meetings this year, with the second cut expected to take place on December 18th, meaning one of the meetings will likely see a 50 basis point cut.

Nathan Thooft, Senior Portfolio Manager at Manulife Investment Management, said: "We are getting closer and closer to 50 basis points." "Officially, we have not changed our stance, with the view for this year being two 25 basis point cuts, so one in November and one in December."

Position data shows that since the Fed's decision last week, the interest rate market has started preparing for the November 7th meeting. Open interest in two-year US Treasury futures has increased significantly. The number of contracts held by traders expiring in December 2024 has risen to about 4.4 million, the highest so far, closely related to the Fed's expected trajectory. Futures bets related to the Secured Overnight Financing Rate (SOFR) for December have also increased significantly.

However, due to mixed signals from several policymakers regarding the November meeting, traders are not heavily betting in one direction at the moment, unlike the situation before the 50 basis point cut on September 18th.

On Tuesday, Fed Governor Michelle Bowman stated that the Fed should cut rates at a "moderate" pace, while two other officials downplayed the possibility of a 50 basis point cut the day before. Meanwhile, Chicago Fed President Austan Goolsbee said that rates need to be cut "substantially".

In the US Treasury cash market, the bullish momentum before last week's Fed meeting remains unchanged, with JPMorgan's net long positions held by clients remaining stable as of September 23rd. During this period, the bond market gained momentum after the Fed's rate cut, with the benchmark 10-year Treasury yield rising by about 12 basis points to around 3.73%.

Here is an overview of the latest position indicators in the interest rate market:

JPMorgan Survey

In the past week, JPMorgan's government bond clients increased both their direct long and short positions by 2 percentage points, while net long positions remained unchanged at 6 percentage points. The number of clients directly shorting is currently at the highest level in a month.

Asset Management and Hedge Funds Long on SOFR Futures

For asset management companies and hedge funds, positions in SOFR futures remain net long, indicating their preparation for further interest rate cuts.

Data from the Commodity Futures Trading Commission (CFTC) shows that in the week ending September 17, the day before the Fed cut interest rates, asset management companies increased their net long positions by approximately $2 million per basis point, while hedge funds closed out approximately $2.6 million per basis point of SOFR futures long positions.

In terms of Treasury futures, during the reporting week, asset management companies increased their long positions by approximately 135,000 10-year Treasury futures contracts, while hedge funds increased their short positions by nearly 300,000 10-year Treasury futures contracts.

Most Active SOFR Options

Over the past week, the SOFR option with a strike price of 98.75 was one of the most active options. This is due to a large number of mildly bearish interest rate positions established through the SFRH5 97.75/98.75 2x3 call spread on March 25, with approximately 80,000 long positions already formed. Additional positions were added to the put options on December 24 following fund flows that included buying the SFRZ4 96.00/95.75 1x2 put spread.

SOFR Options Heatmap

In the SOFR options market, the strike price of 95.50 for contracts expiring in June 2025 remains one of the most actively traded levels, with significant open interest in both call and put options at this price for the December 24 expiration. Recent trades directly purchasing put options expiring on December 24 at a strike price of 95.50 have led to an increase in open interest at that strike. Risk protection activities for options have increased in the past week, including buying the SFRZ4 95.625/95.50 put spread and buying the SFRZ4 95.5625/95.4375 put spread by 1.

Option Premiums Still Close to Neutral

Over the past week, the premiums paid for hedging the market have continued to hover around neutral levels, ranging from neutral to mid-term, while a few weeks ago they soared to bullish premiums as traders anticipated a continued market rebound. At the long end of the yield curve, premiums have started to rise for hedging against selling, which can be seen from the negative skew of long-term bond call/put spreads, as traders anticipate a steeper yield curve