Bond traders do not believe the Federal Reserve may raise interest rates next! Betting on the continuation of the rate cut cycle until 2027
Traders in the U.S. futures and options markets are doubling down on bets that the Federal Reserve will not only continue to cut interest rates this year but that the rate-cutting cycle may extend into next year. It is worth noting that until recently, the market was still betting that the Federal Reserve would implement two 25 basis point rate cuts by the end of this year, before resuming rate hikes in 2027
Traders in the U.S. futures and options markets are ramping up bets that the Federal Reserve will not only continue to cut interest rates this year but that the easing cycle may extend into next year, rather than resuming rate hikes in 2027 as previously expected.
The futures spread linked to the Secured Overnight Financing Rate (SOFR), which closely reflects market expectations for the Fed's policy path, is showing a significant inversion. This indicates that traders are beginning to price in a longer period of easing.
Until recently, the market was betting that the Fed would implement two 25 basis point rate cuts by the end of this year, followed by a return to rate hikes in 2027. However, the growing discussion around the impact of artificial intelligence on the labor market has prompted traders to reassess this expectation.
On Tuesday, Fed Governor Lisa Cook warned that if the widespread adoption of artificial intelligence raises unemployment rates, the Fed may not be able to fully offset the resulting shocks.
The SOFR options market is also showing similar dovish signals. Related trades tend to hedge against the possibility of multiple rate cuts this year, with a significant increase in open interest for certain options contracts, such as call options with a strike price of 98.00 expiring in December.
Since last weekend, the flattening trend of the SOFR spread has noticeably accelerated. Meanwhile, concerns about the "disruptive impact" of artificial intelligence have pressured a range of stocks and pushed long-term U.S. Treasury bonds higher.
Jack McIntyre, a portfolio manager at Brandywine Global Investment Management, stated:
The question is whether artificial intelligence will bring inflationary pressures; perhaps the long end of the yield curve is already reflecting this. The only way AI could potentially lead to inflation is through the construction of data centers and their associated energy demands, which is something the market is already aware of
