Source: Zhitong Finance

Interest rate futures market traders are betting heavily on a reverse bet that will pay off if the Federal Reserve actively relaxes monetary policy this year.

This type of betting occurs on secured overnight financing rate futures, which are closely related to the central bank's key policy interest rate and involve buying contracts in December 2024 while selling contracts expiring in December 2025.

Situations where this deal may be profitable include the Federal Reserve cutting interest rates early before the November presidential election, and the 40 basis point rate cut this year is larger than the market's current expectation.

The deal runs counter to Wall Street's current consensus. In the face of a strong US economy and high inflation, strategists have been lowering expectations of interest rate cuts. This realignment triggered a sharp fall in US Treasury bonds and pushed the US two-year yield to 5% once this week.

On Tuesday, futures positions betting that the 2024 contract will outperform the 2025 contract reached a record high. The sharp increase in positions on Wednesday indicated fresh bets, providing fresh impetus to trading.

According to data from the Chicago Mercantile Exchange, the number of open SOFR futures contracts increased by 133,000 in December 2025, which is equivalent to a profit and loss of 3.3 million US dollars per base point of change. On Tuesday, the 12-month spread broke through the 200-day moving average, which has been maintained for 10 months.

There was also sentiment in SOFR options this week in support of this year's interest rate cut. Investors continued to buy bullish options in addition to major prices on Wednesday, with the goal of lowering the central bank interest rate from the current 5.25% to 5.5% range to a minimum of 3% before the December policy meeting.

If the US economic data suddenly declines, there is still a reason for the Federal Reserve to adopt a more aggressive easing policy than expected by the market in the next few months. The deal may also target the possibility that inflation expectations will rise after this year. This situation may cause the December 2025 contract to perform poorly and the spread to become steep.

Optimistic expectations

Although many analysts lowered their expectations for interest rate cuts due to recent economic data, some people still maintain their optimism about the Fed's easing of monetary policy.

State Street Global Investment Management insists that the Federal Reserve will cut interest rates as early as June. The company's chief investment officer, Lori Heinel, said that the Federal Reserve will begin easing monetary policy before the US presidential election in November to avoid being seen as affecting the election results.

She pointed out that the inflation background still supports this move because the policy has a long lag effect and the quality of recently released data is low. “We still think interest rates may be cut for the first time in June,” Heinel said. “We acknowledge that recent data puts this view in jeopardy, but overall inflation supports interest rate cuts.”

According to information, before data released last week confirmed that inflation exceeded expectations for the third month in a row, Heinel said that the company was betting on cutting interest rates by 50 percentage points in June and cutting interest rates by 150 basis points before the end of the year. Since then, she lowered her interest rate cut expectations to 100 basis points, but this is still double what the market expected.

“The data quality has always been poor, and a lot of big data has been corrected,” Heinel notes. “If taken literally, the Federal Reserve's focus on data dependency may be a challenge.”

Coincidentally, Citi's Andrew Hollenhorst and Veronica Clark also expect the Federal Reserve to cut interest rates drastically. These economists said that it was wrong for Wall Street to cut interest rates this year and hastily make these judgments because the Federal Reserve is still worried that the unexpectedly strong momentum of economic growth may come to a standstill. They both insist that interest rates will be cut by 25 basis points five times this year, and that Fed policymakers will not let go of signs of slowing inflation or economic weakness.

In an interview, Hollenhorst said that it has always included sticky inflation expectations in this year's forecasts, adding, “Our thoughts on the US economic trajectory in 2024 are very different from other forecasters. We think the Fed's reaction will be much more dovish than what the market expects.”

However, it is worth noting that Federal Reserve Chairman Powell said in his latest speech on Tuesday: “The recent data clearly did not give us more confidence. On the contrary, these data suggest that it may take longer than expected to gain this confidence. If the inflation rate continues to rise above the Fed's 2% target, the Fed is likely to keep interest rates at current levels for a longer period of time.”

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