Interest rate suspense fluctuates! As the Federal Reserve interest rate decision approaches, the market suddenly increases its bets on a 50 basis point rate cut.

Global U.S. bond traders are increasing their options bets, believing that the Fed will cut interest rates by at least 75 basis points in the remaining three FOMC monetary policy meetings this year, with an initial cut of 75 basis points expected. At the same time, the SOFR options trading heatmap shows that some traders are betting on the Fed to implement a more aggressive rate cut of up to 50 basis points in the remaining three FOMC monetary policy meetings this year, with some even betting that the rate cuts will mirror those of 2024, i.e. betting on a 100 basis point cut. Traders expect Fed policymakers to cut rates for the first time since 2025 this week, with expectations for a 50 basis point cut in September heating up in the last few trading days, although a 25 basis point cut is seen as the most likely decision. With increasing signs of a softening U.S. labor market, some traders are hedging risks, as although inflation remains sticky, worsening economic prospects may prompt the market to price in larger rate cuts by the Fed for the rest of the year. Overall, traders are preparing for dovish rate cut surprises to prevent a repeat of last year's unexpected 50 basis point cut in September 2024 following unusually weak non-farm payrolls. Some traders still expect the Fed to be "behind the curve" and announce a 50 basis point rate cut this week, while a small number of traders predict pressure from the White House to force a 50 basis point rate cut by the Fed. This week's trading flow related to the Secured Overnight Financing Rate (SOFR) - a rate highly sensitive to the Fed's monetary policy expectations - shows an increase in demand for dovish options expiring in December after the Fed policy announcement on December 10. These SOFR options positions are likely to benefit from rate cuts of up to two half percentage points, or from three separate 25 basis point rate cuts at the September, October, and December meetings. In comparison, the swaps market is currently pricing in a more moderate stance, indicating about 70 basis points of monetary policy easing by the end of the December FOMC meeting, betting that the Fed will cut rates by 25 basis points at each of the three remaining meetings, accumulating to 75 basis points, but not pricing in three rate cuts this year with the nearly 100% certainty seen in the SOFR options market. Expected Fed rate cuts in the year - swaps market pricing in about 70 basis points of easing by the end of December FOMC Of course, for traders betting on even larger rate cuts, the risk lies in Fed Chairman Jerome Powell possibly sending a more cautious signal on the monetary policy path on Wednesday afternoon Eastern time, as the ultimate impact of tariff policy on consumer prices remains uncertain. Economists at Standard Chartered Bank wrote in a report that given the continued weakness in non-farm payroll growth, they expect the Fed to cut rates by 50 basis points "aggressively" this week. However, they said, "Powell is unlikely to give a clear indication of further easing," and officials may have divergent views on future monetary policy measures. The interest rate futures market also shows signs of traders guarding against dovish surprises this week. A block trade, the largest in the history of the federal funds futures market, with a total of 84,000 contracts, showed strong hedging demand for a half percentage point rate cut announcement this week. The futures have been listed on the Chicago Mercantile Exchange as an important tool to guide the Fed's overnight benchmark rate path since 1988. Traders increasing their dovish bets may also be considering policy pressure from the White House. President Donald Trump has criticized Powell for cutting rates too slowly, and at this meeting, his economic policy advisor, recently confirmed as a Fed board member, Stephen Miran, will participate in the FOMC monetary policy decision. The U.S. added only 22,000 jobs in August, compared to economists' median estimate of 75,000. The August unemployment rate rose to 4.3%, the highest since 2021, in line with economists' median estimate. Additionally, the already weak non-farm payroll numbers for June and July were revised down by a total of 21,000, with June's employment data revised to show negative growth for the first time since 2020, leading some interest rate futures traders to leave room for predicting a larger half point rate cut, while also anticipating more accommodative measures by the Fed through the end of 2025 - betting on three consecutive rate cuts before the end of the year. Therefore, after the extremely weak non-farm payroll data was released, some market views suggest that the Fed's FOMC monetary policy decisions should not be seen from a proactive rate cut perspective but rather as slightly lagging behind the actual economic conditions, as continued weak employment and increased political pressure may prompt the Fed to cut rates more aggressively in September and send more dovish signals than generally expected. Here is an overview of the latest position indicators in the interest rate market: JPMorgan U.S. Treasury client survey For the week ending September 15, JPMorgan's U.S. Treasury client survey showed a 2 percentage point decrease in overall short positions, moving to neutral, while long positions remained unchanged. The weekly change brought the net long positions of all clients to their highest level since August 25, highlighting the increasing bullish sentiment in the U.S. bond market as expectations for Fed rate cuts rise. Most active SOFR options In the SOFR options for December 2025, March 2026, and June 2026, a significant amount of new positions have been established around the 96.50 strike price in the past week, with active trading in December 25 (Dec25) call and put options as well as June 26 (Jun26) put options. In recent activity in the December 25 options, several call condor strategies have been established around this strike price, aiming to bet on 25 basis point rate cuts at each of the remaining Fed meetings this year. Additionally, there is significant buying interest in put trees at 96.25 and 96.50 in SFRZ5, as well as call spreads at 96.625 in SFRZ5 options. Skew in the most active SOFR options - top five and bottom five net changes in SOFR option strike prices in the past week The chart shows that SOFR options positions and trades in the past week have been highly concentrated around the 96.50 strike price (especially in Dec25), indicating that interest rate traders' baseline expectations are dovish, with a main scenario of three 25 basis point rate cuts totaling about 75 basis points throughout the year, while employing structured strategies around the 96.50 strike to hedge against the tail risks of a 50 basis point cut or a more hawkish/dovish path thereafter. Overall, traders are focused on the 96.50 strike price: adding bets on the pace of rate cuts by the Fed, but not betting on extremes; using call condors (bullish strategies)/spreads to lock in the most likely path of sequential 25 basis point rate cuts throughout the remaining year, while also hedging against the risks of a 50 basis point cut or a return to a hawkish stance in the future. SOFR options heatmap In the trading activity for the December 25, March 26, and June 26 terms, the 96.50 strike price has been the most concentrated, with significant trading activity in the past week. Most of the positions at this strike price are in the December 25 call options, seemingly targeting an extremely dovish scenario with a half percentage point rate cut at one of the remaining meetings this year. The 95.625 strike price is also highly concentrated, as there are a large number of open positions in December 25 put options at this level. Overall, the heatmap of SOFR options shows that traders are primarily focused on the moderate path of three 25 basis point rate cuts throughout the year, with the 96.50 strike being the "sweet spot," but traders are hedging against the risks of a sudden half point rate cut and the possibility of a lack of rate cuts due to sticky inflation. The baseline expectation in the SOFR options market is a path of three 25 basis point rate cuts (about 70-75 basis points), while preparing for hedging against a 50 basis point cut or a return to a less dovish/hawkish stance. U.S. Treasury options skew The skew in U.S. Treasury options remains neutral near the entire curve, with the long end shifting from a premium in put options to neutrality in recent weeks. Recent trading activity in U.S. Treasury options includes a nominal $27 million strangle sold through December options. CFTC futures positions As of the week ending September 9, traditional asset management institutions have increased their net long positions in long-term U.S. Treasury and ultra-long U.S. Treasury futures, while hedge funds have increased their net short positions from 2-year to 10-year U.S. Treasury futures.