Bond traders are shifting their strategies, now hedging against the Federal Reserve potentially cutting rates in 2027. This move comes after recent economic data largely priced out further interest rate hikes for the remainder of 2026. The options market is seeing wagers that look to offset the risk of a Fed reversal, a sentiment that contrasts with the recent trend in the Treasuries market where long-dated bond yields reached multiyear highs.
This dovish positioning is emerging as traders react to signs of economic weakness in the US. Data released last week indicated an easing of inflation and consumer demand in July, which reduced expectations for a rate hike at the September 16 policy meeting. Options traders have started positioning to fade the amount of rate hikes previously priced into the swaps market, with some even looking to hedge against rate cuts by mid-2027.
Jeff Schuh, head of the interest rates desk at Constitution Capital, noted a decrease in concerns about a hike, with positions betting on that outcome being liquidated. Significant trades include buyers of September options targeting a Fed hold at the next meeting and buyers of call options with March and June 2027 expiries, which would profit from a shift towards rate cuts. Interest rate swaps currently price in 9 basis points of a quarter-point hike for the September meeting and about 40 basis points of tightening by June next year. The J.P. Morgan Treasury Client Survey for the week to August 17 showed investors cutting short positions by 4 percentage points, moving to a neutral stance.
Additional economic data supporting this shift includes an unexpected loss of 23,000 jobs in July, a significant decline in US retail sales for the month, and weakening consumer sentiment. These factors led to September rate hike odds being halved from 68% just two weeks prior. The shift in positioning is also evident in SOFR options, with significant increases in open interest across various strikes for September 2026, December 2026, and March 2027, particularly in call spreads and outright calls that would benefit from rate cuts. The skew in Treasury options remains in favor of puts for long-bond futures, indicating a premium paid to hedge against a bond selloff.
