Source: Caixin.

Some traders in the US interest rate options market are currently taking a bold bet on the Federal Reserve's rate-cutting path: betting that the Federal Reserve will cut interest rates by as much as 300 basis points in the next nine months!

In the past three trading days, data from the options market linked to secured overnight financing rates (SOFR) shows that these increasing bets will benefit if the Fed lowers its key interest rate to 2.25% before the first quarter of 2025.

This means that the Fed will need to cut interest rates by at least 300 basis points from the current level-namely, it will need to cut interest rates 12 times with a magnitude of 25 basis points per cut.

Considering that from now until March next year, the Fed will only hold a total of six interest rate meetings, this also suggests that if the Fed really wants to cut interest rates so much in nine months, it will need to cut interest rates by an average of 50 basis points per meeting. If the initial interest rate cut unfolds in increments of 25 basis points, at least a 75 basis point cut will be needed at some meetings.

Undoubtedly, the above-mentioned extreme dovish bets, compared with the fair estimation of the current interest rate futures market, can be described as "ten thousand miles" apart.

At present, market participants generally expect that the Fed will cut interest rates by about 75 basis points in these nine months. The rate dot plot released by Fed officials earlier this month showed that the Fed will only cut interest rates by 25 basis points to the end of this year, with a total cut of 125 basis points to the end of 2025.

And in connection with the two large "extreme bets" that emerged on the interest rate futures market we introduced last Friday, more and more market participants are currently deviating from the mainstream expectations of the market and the Fed's own forecasts, and are beginning to make bets on some tail risk outcomes, such as the Fed's rapid and extreme interest rate cuts...

However, as many such contracts are traded anonymously, it is difficult to determine the institutions or groups behind these bets.

So why are these traders making such aggressive bets on easing?

The reason is not difficult to find, because if the Fed is really so dovish in the next six months- cutting interest rates by 300 basis points in nine months, then only one situation can occur: the US economy will suddenly fall into rapid recession!

Whether this scene will occur in a few months, we obviously cannot predict. But from the recent low performance of a series of US economic data and the warning signals sent out by many economic recession indicators, it is not difficult to understand why some people are taking such a gamble...

According to data released by the US Chamber of Commerce on Tuesday, due to expectations of weak business conditions, job markets, and income prospects, US consumer confidence weakened again this month. The US Chamber of Commerce Consumer Confidence Index for June fell to 100.4, with May data revised down from 102 to 101.3. In terms of specific sub-indices, the expectation index has been below 80 for five consecutive months (which usually indicates the critical value of an economic recession), and is currently hovering near the lowest point in nearly a decade.

Overall, in terms of macroeconomic data in the United States, both "hard data" and "soft data" are heading downward. "Hard data" has fallen to a 21-month low.

Note: The red line represents hard data and the green line represents soft data (survey data).

Some economic recession warning signals are flashing red again.

As shown in the following figure, the US leading economic index (LEI) has fallen by 14.7% from the peak of this economic cycle. In the past 65 years, this drop has only occurred during an economic recession period. This index comprehensively measures the performance of US labor market data, manufacturing data, real estate data, and even stock and bond markets.

In addition, on Tuesday, the 2-year/10-year spread of US Treasury bonds fell below -50 basis points for the first time this year. As of the end of the New York session, the 2-year Treasury yield rose 1.1 basis points to 4.745%, and the 10-year Treasury yield rose 0.8 basis points to 4.245%.

This is the most watched part of the yield curve. Generally, the yield curve of US bonds tilts upward, with short-term yields lower than the higher-risk long-term yields. However, since mid-2022, the yield curve has been inverted, implying market expectations of an economic recession.

Ian Shepherdson, chief economist at Pantheon Macroeconomics, recently warned that "(US economic) slowdown is real and continues to develop".

In fact, some Fed officials have also expressed caution about the downside risks to the economy this week. This year's FOMC voter and president of the San Francisco Fed, Daly, said that the US labor market is approaching a turning point, and further slowdown could mean rising unemployment. Daly urged policymakers to remain vigilant and keep an open attitude towards various scenarios that may occur in the economy.

Editor/tolk