Traders are increasingly wagering that the Federal Reserve's future interest rate hikes will be smaller than what the market currently prices in. As rate swap markets now reflect expectations for a cumulative three 25-basis-point increases by June of next year, some investors have started building hedging positions through SOFR options, guarding against the possibility that the actual pace of tightening turns out to be significantly more modest.
The bulk of these positions are concentrated in call options on SOFR futures expiring in March 2027. As of Monday's close, open interest on those March 2027 SOFR calls stood at roughly 2.7 million contracts, outpacing puts on the same tenor by about 1 million contracts. This positioning pattern signals a growing demand for protection against a shallower rate hike trajectory.
Christian Hoffmann, head of fixed income at Chicago-based asset manager Thornburg Investment Management, disagrees with the current market consensus on Fed policy. In his view, four rate hikes within a year would be a fairly aggressive response to the prevailing economic environment, one that could have meaningful repercussions for the broader macroeconomy.
Since SOFR futures prices move inversely to market-implied short-term rates, holding call options on SOFR futures essentially serves as a hedge against the risk that rates end up lower than current expectations. Over the past week, trading volume across multiple strike prices for the March 2027 contract has picked up noticeably, with new open interest at the 97.00 and 96.25 strikes reaching 94,262 and 102,713 contracts, respectively.
Jeff Schuh, director of interest rate trading at Constitution Capital, notes that recent capital flows may reflect expectations for "one or two cautious hikes" remaining from the Fed, followed by a period of relative range-bound activity. At present, the March 2027 SOFR options market even shows positions betting on an overnight rate near 3%, a level well below the current effective federal funds rate of roughly 3.88%. Reaching such a level would require the Fed to enter a rapid easing cycle by 2027, a scenario that currently remains a contrarian hedge direction pursued by only a minority of traders.
The Fed's own latest rate projections do not point to an aggressive path either. Citing recent remarks from Richmond Fed President Thomas Barkin, the median forecast among Fed officials implies possibly one more hike before year-end, while the median projection for 2027 shows no further tightening. Speaking in Baltimore on Tuesday, Barkin indicated that inflation pressures may take longer to dissipate, but stopped short of specifying how many additional hikes might be needed. He described the U.S. economy and labor market as remaining in solid shape, with consumer spending resilient and activity strengthening in sectors beyond artificial intelligence investment.
He also cautioned that some shocks once viewed as temporary have not faded quickly, and that new cost pressures could emerge. As a result, the Fed needs to observe whether inflation cools on its own or becomes more entrenched due to robust demand.
Bond market positioning has shifted in tandem, with some investors preparing for slower economic growth and lower rates than currently anticipated. George Bory, chief investment strategist for fixed income at Allspring Global Investments, said the recent market environment has prompted him to increase his long bond positions. According to the latest JPMorgan client survey, net long positioning in U.S. Treasuries among investors rose by 4 percentage points in the week ending September 21, reaching the highest level since last November, while net short positioning declined by 6 percentage points during the same period.
Bory argues that higher yields, tighter monetary policy, and elevated oil prices are all combining to pressure economic growth. If these factors continue to weigh on the economy through the fourth quarter and into next year, a slowdown could prompt a reassessment of the Fed's policy trajectory.
Comments