Market participants are actively seeking protection against the possibility that the Federal Reserve’s rate-hiking cycle could prove less aggressive than current pricing suggests.
Interest rate swaps currently reflect expectations for three quarter-point rate increases by June of next year. This outlook was reinforced last week when Fed policymakers voted to raise the federal funds rate target range by 25 basis points and signaled that further tightening is necessary to curb inflation. Meanwhile, this hawkish consensus is prompting some traders to hedge their exposure using options tied to the policy-sensitive Secured Overnight Financing Rate (SOFR). Over the past week, demand for call options linked to March SOFR futures has risen, indicating growing interest in guarding against a less aggressive Fed path.
Christian Hoffmann, head of fixed income at Thornburg Investment Management, noted, "The market is pricing in three hikes from here. I would take the other side of that trade." He added, "Four hikes within a year would be a fairly aggressive response to the current economic backdrop, and it would have material knock-on effects on the macro economy." Open interest levels have increased over the past week, suggesting that new hedging positions are being established.
Oil prices remain a critical variable and continue to exert significant influence on the Fed’s policy trajectory and market outlook. Crude prices, driven higher by factors related to the Middle East conflict, recently pushed the yield on the 10-year U.S. Treasury above 5% at one point. On Tuesday, Treasury prices moved in tandem with oil as Saudi Arabia sought to restore crude flows along a key pipeline, while 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 fixed income investment strategist at Allspring Global Investments, said the recent market environment has prompted him to increase his bullish positioning in the bond market. He is not alone in this approach. The latest investor survey from JPMorgan shows that direct long positioning has increased to its highest level since November of last year.
Bory explained, "Higher yields, a higher current policy rate, and higher oil prices all essentially act as a tax on economic growth." He added, "So some of that pressure could ultimately start to show up in the fourth quarter, or even extend into next year." He also noted that an economic slowdown, easing Middle East tensions, and cooling artificial intelligence (AI) spending could all contribute to fewer rate hikes from the Fed.
As of Monday’s close, open interest in SOFR call options expiring in March 2027—representing new risk exposure—stood at roughly 2.7 million contracts. That figure is about 1 million contracts higher than put options with the same maturity, indicating that traders are leaning toward hedging for a Fed policy path that will be more dovish than current market pricing suggests.
Jeff Schuh, head of rates trading at Constitution Capital, commented, "These flows could imply that the Fed has one or two more cautious hikes left, but after those, the market may enter a period of relative range-bound trading." Open interest in March 2027 SOFR calls is now 60% higher than puts.
Additionally, a prominent positioning target in the March 2027 SOFR options is an overnight rate near 3%, well below the current effective federal funds rate of 3.88%. Reaching that level would require the Fed to quickly initiate a rate-cutting cycle by early 2027, a scenario few currently anticipate.
Here is an overview of various positioning metrics in the rates market over the past week: The JPMorgan U.S. Treasury client survey for the week ending September 21 showed direct long positioning increased by 4 percentage points, reaching its highest level since November, while short positioning declined by 6 percentage points.
In SOFR options positioning, across the December 2026, March 2027, and June 2027 tenors, the March 2027 calls saw significant new risk exposure at multiple strike prices over the past week, including the 97.00 strike (adding 94,262 contracts) and the 96.25 strike (adding 102,713 contracts). This was largely driven by buying of SFRH7 96.25/97.00 2x3 call spreads. There was also demand for similar structures via the SOFR March 2027 96.75/97.75 2x3 call spreads.
However, the most actively traded strike over the past week was 95.4375, primarily due to a surge in December 2026 put volumes, with flows including purchases of SFRZ6 95.9375/95.8125/95.4375/95.3125 put condors.
Due to the heavy trading volume in the SOFR March 2027 97.00 call over the past week, the 97.00 strike has now become the highest open interest strike across the December 2026, March 2027, and June 2027 tenors. Open interest at the 96.50 strike also remains elevated, with a large amount of December 2026 call positions still outstanding.
In long-dated Treasury contracts, the option premium paid to hedge U.S. Treasury futures risk remains skewed toward puts, although it has moved closer to neutral compared with several weeks ago. This suggests that the premium traders are paying to hedge against a sell-off in the long end of the yield curve is declining. Over the past week, skewness across the front-to-middle tenors has remained near neutral levels.
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