Traders in the options market are increasing hedges against the possibility that the Federal Reserve will raise interest rates less than current market pricing suggests. Interest-rate swaps indicate expectations for three quarter-point rate hikes by June next year, a view solidified after the Fed's recent quarter-point hike and signaling of further increases. However, some traders, like Christian Hoffmann from Thornburg Investment Management, believe four hikes in a year would be too aggressive for the current economic backdrop, leading them to bet against this hawkish consensus.
Demand for call options linked to March SOFR futures has risen, reflecting a desire for protection against a less aggressive Fed. Open interest in March 2027 SOFR calls reached approximately 2.7 million, about 1 million more than puts, indicating a preference for hedges against a shallower policy path. One notable position in March 2027 SOFR options targets an overnight rate closer to 3%, significantly below the current 3.88% effective fed rate, implying a swift cutting cycle in 2027.
Several factors contribute to this outlook, including the potential for a slowing economy, easing Middle East tensions, and moderating spending on artificial intelligence, which could lead to fewer Fed hikes, according to George Bory of Allspring Global Investments. Bory has increased his bullish positions in the bond market, a sentiment echoed by JPMorgan Chase & Co.'s investor survey showing an increase in outright long positions to the highest level since last November. Oil prices, particularly those influenced by geopolitical events, remain a key variable impacting the Fed's path and market outlook, as higher yields, monetary policy, and oil prices act as a tax on growth.
