(Bloomberg) — Traders in the options market are shielding themselves from the possibility that the Federal Reserve raises interest rates less than markets are currently pricing in.
Interest-rate swaps now reflect expectations for three quarter-point rate rises by next June, a view that solidified after central bank policymakers voted last week to raise their lending benchmark by a quarter point and signaled more increases will be needed to keep inflation at bay.
This hawkish consensus is leading some traders to seek to hedge their bets using options linked to the policy-sensitive Secured Overnight Financing Rate. Demand over the past week has been building for calls tied to March SOFR futures, indicating growing appetite for protection against a less aggressive Fed.
“The market’s pricing in three hikes from here. I would take the other side of that,” said Christian Hoffmann, head of fixed income at Thornburg Investment Management. “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.”
Oil remains a key variable and continues to heavily influence the outlook for the Fed’s path and markets, with the Iran war-related rise in crude prices contributing to a recent surge in US long-term yields past 5%. On Tuesday, Treasuries fluctuated along with oil as Saudi Arabia looked to resume flows on a vital pipeline and investors focused on the annual gathering of diplomats at the United Nations in New York for clues on progress toward reopening the Strait of Hormuz.
George Bory, chief investment strategist of fixed income at Allspring Global Investments, said recent market conditions have prompted him to increase his bullish positions in the bond market. He’s not alone: JPMorgan Chase & Co.’s most recent investor survey revealed an increase in outright long positions to the most since last November.
“Higher yields, higher monetary policy now, and higher oil prices are all effectively a tax on growth,” Bory said. “So some of that pressure may ultimately start to manifest itself as we get into the fourth quarter and perhaps into next year.”
A slowing economy, along with easing Middle East tensions and moderating spending on artificial intelligence, may result in less Fed hikes, Bory said.
As of Monday’s close, open interest — or new risk — in March 2027 SOFR calls was about 2.7 million. That was around 1 million more than puts in the same tenor, signaling traders were favoring hedges that the Fed’s policy path will be more shallow than currently priced for that time.
“The flow could be saying the Fed has another one or two cautious hikes left, but after those hikes the market may settle into a relatively range-bound period,” said Jeff Schuh, head of the interest rates desk at Constitution Capital.
One standout position in March 2027 SOFR options was targeting an overnight rate closer to 3%, well below the current 3.88% fed effective rate. To hit that target, central bankers would need to embark on a cutting cycle to commence swiftly into 2027, something few expect currently.
Here’s a rundown of positioning indicators across the rates market over the past week:
JPMorgan Treasury Client Survey
In the week up to Sept. 21, investors’ outright long positions rose 4 percentage points to the most since November, with short positions cut by 6 percentage points.
Across SOFR Dec26, Mar27 and Jun27 options, the past week has seen a huge amount of risk added across various strikes in March 2027 calls, including the 97.00 strike ( 94,262) and 96.25 strike ( 102,713) largely due to heavy buying in the SFRH7 96.25/97.00 2×3 call spread. There has also been demand for a similar structure via SOFR Mar27 96.75/97.75 2×3 call spreads. The 95.4375 strike has been the most active over the past week however due to jump in Dec26 puts, where flows have included buyers in SFRZ6 95.9375/95.8125/95.4375/95.3125 put condors.
Due to a heavy amount of SOFR Mar27 97.00 calls trading over the past week, the 97.00 strike is now the most populated across Dec26, Mar27 and Jun27 tenors. Open interest also remains elevated in the 96.50 strikes, where there remains a heavy amount of Dec26 calls positioning.
The premium paid to hedge Treasury futures in the long-bond contracts continues to favor puts, although it is closer to neutral vs a couple of weeks, ago signaling that traders are paying a decreasing premium to hedge a selloff in the long-end of the curve. Skew in the front end out to intermediates has remained close to neutral over the past week.
–With assistance from Elizabeth Stanton and Ye Xie.
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