Options traders have increased their bets on the Fed cutting interest rates by 50 basis points this month, reflecting growing speculation in the market that policymakers will take proactive measures to prevent an economic downturn.

Options linked to the Secured Overnight Financing Rate (SOFR) show a significant increase in open interest in some call contracts expiring on September 13, the five days before the FOMC issues its rate statement. If this Friday's non-farm payrolls report and next week's Consumer Price Index (CPI) data show a cooling job market and inflation, it will be enough evidence for the Fed to more quickly relax its policies, resulting in profitable returns for these positions.

Currently, swap contracts indicate a one-third chance of a 50 basis point interest rate cut by the Fed this month. Priya Misra, an investment portfolio manager at JPMorgan Asset Management, said, "The labor market has slowed down and is now catching the attention of the Fed. Considering that the current fund rate is between 5.25% and 5.5%, the economy is slowing down, and the lag and volatility between monetary policy and the economy are notoriously long, I believe there is a strong rationale to initially cut rates by 50 basis points."

The bond market has recently rebounded strongly, pushing the yield on 10-year U.S. Treasuries back to last month's low point when unexpectedly weak job growth raised concerns about a U.S. recession. JPMorgan's survey found that clients are increasing their bullish bets on U.S. Treasuries and reducing their short positions.

Economists expect Friday's data to show a slight rebound in job creation in August to around 0.165 million, enough to bring down the unemployment rate, but still far from the strong growth earlier this year. During the COVID-19 pandemic, the credit crisis, and the bursting of the internet bubble leading to the stock market crash, the Fed has cut rates by 50 basis points or more. However, it now appears that the necessity for such hasty action is less apparent, as the U.S. economy is still growing and U.S. stocks are not far from their peak this year after a recent downturn. However, after Fed Chairman Powell's speech at Jackson Hole, optimism about this move has accelerated in the options market, with some believing that his speech has opened the door to this approach.

Traders have recently suffered losses from betting on the path of the Fed, so many remain cautious about this risk. For example, at the end of 2023, the market rebounded strongly as it anticipated the Fed starting the year with rate cuts, but the gains evaporated when the economy showed surprisingly strong performance.

Jonathan Cohn, Head of Rates Strategy at Nomura Securities International, said, "There is a market divergence as to whether the first rate cut in September will be 25 basis points or 50 basis points. This largely depends on the results of the jobs report. If certain thresholds are met in terms of unemployment and layoffs, then a 50 basis point cut is definitely worth considering."

Neil Dutta of Renaissance Macro Research said, "The market seems to see the rate cut in September as a coin toss between 25 and 50 basis points. I believe the risk of a 25 basis point cut is the same as the risk of skipping the July meeting. If the next data point causes investors to speculate on the Fed's decision, it will exacerbate the bet that the Fed is behind the curve. You should cut 50 basis points when you can, rather than waiting until you have to."

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Editor/Somer