Experienced traders specializing in derivatives like options are increasingly leaning towards excluding expectations for Federal Reserve rate cuts in 2026, instead betting that the Fed will hold rates steady for the entire year. Their wagers would yield positive returns if the Fed indeed maintains the benchmark rate unchanged for a prolonged period, as they anticipate. Since the release of various labor market statistics in December, coupled with the latest CPI data showing a steady cooling of US inflation, traders' expectations for Fed rate cuts in 2026 have been continuously diminishing. Mixed labor market signals, including December's non-farm payrolls, suggest a slight year-end recovery in the US labor market, marginally but significantly strengthening the "soft landing" narrative.
The theme of "rate cut trading" began showing clear signs of weakness starting last Friday, when the latest US non-farm payroll data indicated a moderate recovery in employment and an unexpected drop in the unemployment rate. This almost entirely eliminated the possibility of a rate cut announcement at this month's FOMC policy meeting and prompted an increasing number of interest rate futures traders to significantly push back their expected timing for rate cuts in the coming months. Following the release of December's non-farm payroll and unemployment data last Friday, the CME FedWatch Tool indicated that interest rate futures traders scaled back their 2026 Fed rate cut bets from the three cuts priced in at the end of 2025 to just two cuts. Traders now broadly bet that the first rate cut in 2026 will occur in June, rather than the previously anticipated March.
However, the rate cut expectations reflected by the CME FedWatch Tool still remain higher than the median projection of Fed officials shown in the FOMC dot plot, which indicates only one rate cut for 2026. A stabilizing and increasingly robust labor market reinforces the "soft landing" narrative for the US economy, while inflation remains above the Fed's target, giving the central bank no urgent reason to announce further rate cuts. The possibility of the Fed holding the benchmark rate steady throughout 2026 is also increasing.
Recent options flows linked to the US Secured Overnight Financing Rate (SOFR) market are telling a more hawkish story regarding market interest rate pricing. A growing number of traders believe the Fed will not cut rates in 2026. A steadily recovering labor market and a slow pace of inflation cooling may significantly weaken the logic for further rate cuts following the three consecutive hikes announced at the final three FOMC meetings of 2025, especially against a macroeconomic backdrop where inflation still exceeds the Fed's long-term 2% target.
Statistical data released last Friday by the US Bureau of Labor Statistics showed that non-farm payrolls increased modestly by 50,000 last month, just slightly below the economists' consensus expectation of a 60,000 increase, after substantial downward revisions to the employment data for the previous two months (with October even showing a contraction of over 100,000 jobs). The unemployment rate unexpectedly showed positive momentum, dropping significantly to 4.4% from November's revised 4.6%, turning lower after the end of the record-long federal government shutdown, and beating the economists' consensus expectation of 4.5%, reflecting a notable decrease in the number of directly unemployed individuals.
The December CPI data released by the US Bureau of Labor Statistics on Tuesday showed core CPI cooling steadily but remaining stubbornly high and insufficient to prompt a Fed rate cut this month. In US markets, various December employment statistics indicated that the US labor market retained some growth momentum heading into the new year after a noticeable hiring slowdown in 2025. These data points marginally but significantly strengthened the "soft landing" narrative, with the US labor market presenting a combination of "moderated layoffs + rebounding hiring intentions," largely fitting the employment profile required for an economic soft landing trajectory of "slower growth without stalling."
According to data from employment placement firm Challenger, Gray & Christmas Inc. (the US Challenger Job Cuts report), US companies announced fewer layoffs last month while planning to increase hiring. Challenger data showed that US companies announced 35,553 job cuts in December, unexpectedly hitting the lowest level since July 2024 and falling significantly from the high layoff levels of the previous two months. Furthermore, survey data indicated that US employers planned to add nearly 10,500 new positions, significantly exceeding market consensus expectations and marking the highest level for any December since 2022.
Data from ADP Research (the "small non-farm payrolls") also suggested the job market may have gained some mild expansion momentum towards year-end, showing US companies added 41,000 jobs in December after a significant decline the previous month. An indicator for service-sector hiring expanded last month to its strongest level since February. Statistical data released by the US government last Thursday showed US labor productivity accelerated in the third quarter to its strongest growth pace in two years, further indicating that the AI-driven efficiency wave led by the emergence of ChatGPT is significantly dampening wage-induced inflationary pressures.
Meanwhile, for the week ending January 3rd (including the New Year's holiday), US initial jobless claims increased by 8,000 from the previous week to 208,000, slightly below the market consensus of 210,000 and still well below last year's average level of initial claims, reinforcing signs of a recovering labor market.
Overall, a series of December labor market data indicate that US companies' hiring pace rebounded modestly at a gentle rate in December, coupled with a steady cooling of inflation, suggesting the US economy remained remarkably resilient entering 2026 and is likely to lay a significant foundation for a complete "soft landing." In the view of Wall Street giants like Goldman Sachs and Morgan Stanley, the primary macroeconomic narrative of a US "soft landing" is expected to gain significant traction in 2026—meaning the US economy is projected to grow faster than market expectations in 2026.
"We are facing an increasingly unpredictable employment situation, followed by a stubborn inflation problem," said David Robin, rates strategist at TJM Institutional Services LLC. "From a practical data perspective, the probability of the Fed holding rates steady at least until March has increased significantly, and with each subsequent meeting that passes without a cut, the probability of the Fed holding rates steady becomes greater."
Even though the swap market still reflects a general expectation of a half-percentage-point rate cut in 2026, recent fund flows in Secured Overnight Financing Rate (SOFR) options, closely tied to the Fed's short-term benchmark rate, reveal more hawkish signals. Most new options positions are concentrated in March and June, hedging against the scenario that the Fed's next rate cut decision might be further delayed. Other SOFR options positions targeting longer-dated contracts would benefit substantially if the Fed maintains rates unchanged throughout all of 2026, with the benchmark rate expected to remain in the current 3.5%-3.75% range until year-end.
"Whether the market thinks the Fed will hold steady—whether that's a 5%, 10%, or 20% probability—these trades are cheap, and if you are a disciplined risk manager, you would choose to believe this pricing," said Robin from TJM in an interview. Some Wall Street strategists are also beginning to adopt similar views. Following last Friday's non-farm payroll data, a team of economists and strategists from J.P. Morgan said they no longer forecast further Fed rate cuts this year and instead predict a rate hike in 2027. A month ago, HSBC Securities forecast that the Fed would not adjust the benchmark rate until 2027.
A latest research report from Goldman Sachs economists shows the Wall Street giant now expects the Fed to cut rates by 25 basis points each in June and September, a full postponement from previous forecasts of March and June. Morgan Stanley stated it has delayed its expectation for the timing of Fed rate cuts this year from January and April to June and September, forecasting 25 basis points each time. The firm emphasized that the core logic for cuts has shifted from "stabilizing employment" to "combating stubborn inflation," requiring policy action to wait until the impact of tariffs is fully apparent and inflation clearly retreats towards the 2% target.
The shift in SOFR options market sentiment occurs against the backdrop of escalating tensions between the Trump administration and Fed Chair Jerome Powell, who revealed last Sunday that the US Department of Justice had initiated a criminal investigation against him, which he stated was clearly politically motivated. This move has reignited market concerns about central bank independence and triggered a backlash from global central banking systems, US investors, and lawmakers, who have actively defended Powell. This has also cooled bullish sentiment in the US Treasury market.
A J.P. Morgan survey of client positioning changes for the week ending January 12 showed short positions increased by 4 percentage points, while long positions increased by 3 percentage points. The net result was the smallest net long positioning in the US Treasury market since October 2024, with the largest short position since October 6th of last year. The chart above shows the J.P. Morgan US Treasury client positioning survey—client net long positions hit the lowest since October 2024.
The following is an overall overview of the latest positioning indicators in the rates market: In SOFR options expiring in March, June, and September 2026, there was significant demand over the past week to hedge downside risk via March options. The 96.375 strike saw active participation through popular downside flows, including buying SFRH6 96.375/96.3125 put spreads and SFRH6 96.4375/96.375/96.3125 put flies. Other flows with increased liquidity included buying SFRM6 96.5625/96.50/96.4375 put flies. The chart above shows the most active SOFR option strikes—the top five and bottom five weekly net changes in SOFR option strikes. The establishment of significant put options and structural protection positions reflects a notable weakening of rate cut expectations.
SOFR options expiring March 26 (Mar26) were particularly active over the past week, especially the 96.375 strike, which concentrated a large number of put/hedge positions. These structural options are SOFR strategies that gain value if short-term rates "remain high or stop falling," as SOFR pricing is highly correlated with the Fed's policy rate outlook. In the rates options market, the 96.375 level generally corresponds to a market-expected annualized rate of approximately 3.625%. Significant buying of downside protection implies traders broadly wish to avoid a further substantial decline in rates (i.e., avoiding a deeper Fed rate-cutting cycle).
Looking at the specific distribution of SOFR open interest, the market is clearly hedging or speculating on the scenario of "the Fed delaying rate cuts or even maintaining the benchmark rate unchanged for the entire year," highlighting that the market is pushing the potential rate cut window further back. This, together with the non-farm payroll data and inflation dynamics, strengthens the probability of "no rate cuts this year." In the SOFR options open interest for the September 26, 2026 expiry, the 96.50 strike still holds the highest position in terms of risk exposure held by traders, with substantial March and June options positions. The 96.375 and 96.3125 put options also maintain significant open interest exposure, while the 96.75 strike still holds large amounts of March and June call options. The chart above illustrates SOFR options open interest—the top 10 option strikes for March, June, and September 2026 expiries.
The currently most concentrated risk zone in the SOFR options market (around the 96.50 strike) reflects traders' pricing preference for the scenario of the benchmark rate "remaining at current levels for an extended period, with the rate cut cycle further delayed." The highest volume of open interest is currently clustered around 96.50 (implying an implied rate of approximately 3.50%) and extends across maturities to June and September, indicating that the market expects the Fed is more likely to maintain rates within the current range for a longer period and push any rate cut expectations to more distant months or assign them a lower probability. Active long/short positions across multiple maturities suggest the market anticipates rates may oscillate within the current range rather than decline rapidly. This latest SOFR open interest structure is largely consistent with the supportive non-farm payroll data and high inflation backdrop mentioned above, collectively indicating that rates market traders are gradually abandoning expectations for significant rate cuts this year and shifting towards a more persistent, more hawkish scenario of "maintaining the benchmark rate."
Over the past week, the premium investors paid to hedge US Treasury risk tended to skew towards the front end to 10-year US Treasury options, while remaining near neutral in long-term Treasury options. This slight change reflects investors paying a marginally higher premium to hedge against bond market rallies in 2-year, 5-year, and 10-year Treasury futures, rather than for put protection or higher yields. This near-neutral stance in long-term Treasury options is consistent with current market expectations that "the Fed may not cut rates significantly in 2026"—investors are only lightly hedging risk, not making heavy bets on rate cuts.
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