3 hrs ago
Traders Hedge Against a Shallower Federal Reserve Rate-Hike Cycle
Markets currently expect the Federal Reserve to raise interest rates three more times by next June.
Some traders think that forecast may be too aggressive.
They are buying financial contracts that could protect them if rates rise less than expected.
These contracts are linked to the Secured Overnight Financing Rate, or SOFR.
March 2027 SOFR calls have attracted especially strong demand.
One large group of trades points to an overnight rate near 3% in March 2027, below the current 3.88% federal funds rate.
Investors say high oil prices and high borrowing costs could slow the economy.
If growth slows, the Federal Reserve might stop raising rates sooner or eventually cut them.
Interest-rate swaps reflect expectations for three quarter-point Federal Reserve increases by next June.
Traders are buying options linked to March 2027 SOFR futures to hedge against a less aggressive Fed.
March 2027 SOFR call open interest reached about 2.7 million, roughly 1 million above puts.
Higher oil prices, Treasury yields and monetary policy are raising concerns about slower economic growth.
Some investors expect a slowing economy and easing tensions to limit rate increases after one or two more hikes.
- Who
- Interest-rate traders, Federal Reserve policymakers and bond-market investors.
- What
- Traders are increasing options hedges against a shallower Federal Reserve rate-hike cycle than markets currently anticipate.
- Where
- The activity is in US interest-rate, SOFR and Treasury markets; investors were also watching developments at the United Nations in New York.
- When
- The positioning described developed over the past week; the Federal Reserve raised its benchmark rate by a quarter point last week, and the data cited was current through Sept. 21 and Monday’s close.
- Why
- Traders are concerned that high oil prices, elevated yields and tighter monetary policy could slow economic growth and reduce the need for future rate hikes.
Shallower-cycle hedgers
Hawkish-rate market pricing
Future rate increases
Shallower-cycle hedgers
Traders and investors cited in the report believe the Fed may have only one or two cautious hikes left before rates settle into a range or the economy weakens.
Hawkish-rate market pricing
Interest-rate swaps are pricing three additional quarter-point increases by next June after policymakers signaled that more hikes are needed to contain inflation.
Economic outlook
Shallower-cycle hedgers
Investors including George Bory argue that higher oil prices, higher rates and elevated yields act as a tax on growth, potentially reducing future Fed hikes.
Hawkish-rate market pricing
The hawkish view emphasizes persistent inflation concerns and the need for further monetary tightening, although the article does not attribute a specific forecast to all hawkish traders.
Bond-market positioning
Shallower-cycle hedgers
Bory increased bullish positions in bonds, while JPMorgan’s survey showed long positions at their highest level since last November.
Hawkish-rate market pricing
Treasury-options pricing still showed a premium for puts in long-bond contracts, indicating continued demand for protection against a selloff, though that skew had moved closer to neutral.
Key facts
- Current market pricing
- Interest-rate swaps reflect three quarter-point rate increases by next June.
- SOFR call open interest
- March 2027 SOFR calls had about 2.7 million in open interest.
- Call-versus-put positioning
- March 2027 call open interest was about 1 million higher than put open interest.
- Current federal funds rate
- The federal effective rate was 3.88%.
- Notable options target
- One position targeted an overnight rate near 3% in March 2027.
- Treasury survey
- JPMorgan’s survey showed outright long positions rising four percentage points and short positions falling six percentage points in the week through Sept. 21.
Quotes
Christian Hoffmann
Head of fixed income at Thornburg Investment Management
“The market’s pricing in three hikes from here. I would take the other side of that. Four hikes over the course of a year is a pretty dramatic response to the economic backdrop and would have real reverberations through the macro economy.”
livemint.com
“Higher yields, higher monetary policy now, and higher oil prices are all effectively a tax on growth. So some of that pressure may ultimately start to manifest itself as we get into the fourth quarter and perhaps into next year.”
livemint.com
