Investors are quietly betting on a stealth jumbo-sized rate cut
Investors are growing increasingly confident that the Federal Reserve will have to play catch-up on interest rates, as policymakers face mounting criticism for being too slow to respond to rising unemployment.
While most analysts still expect two more quarter-point cuts this year, the Secured Overnight Financing Rate (SOFR), a key benchmark for short-term borrowing costs, is signaling a different outlook.
Open interest in SOFR call options betting that rates will fall to 3.5% by year-end has surged to 926,000 contracts, a record high, according to Bloomberg data cited by The Kobeissi Letter.
That level of positioning suggests markets are pricing in about 75 basis points of cuts from the current 4.25% rate. In other words, one of the next two cuts could be a jumbo 50-basis-point reduction, either in October or December.
“Open interest for SOFT call options on this bet has tripled since July,” The Kobeissi Letter noted.
A larger move wouldn’t be unprecedented, even in modern history. The Fed last delivered a 50-basis-point cut in September 2024, and before that, during an emergency meeting in March 2020 at the onset of the Covid lockdowns.
The Fed’s next two meetings are scheduled for Oct. 28-29 and Dec. 9-10. The December meeting carries extra significance, as it contains the Fed’s updated forecasts for unemployment, GDP growth, inflation, and interest rates.
A clear shift in market psychology
The latest SOFR data underscores a growing shift in market sentiment: investors are bracing for deflationary pressures and a faster pace of Federal Reserve rate cuts, even as official commentary and pundit debates remain fixated on inflation.
As InvestorsObserver reported earlier, macro analyst Tyler Neville recently pointed out that the two-year U.S. breakeven inflation rate, which measures the difference between the two-year Treasury yield and its inflation-protected counterpart, has dropped below 2.5%.
That decline suggests traders now expect inflation to average under 2.5% over the next two years, prompting Neville to conclude bluntly: “Deflation is the problem.”
The warning may seem premature with headline inflation still near 3% and indicators of stagflation, a toxic mix of rising prices, rising unemployment, and slowing growth, still flashing.
However, economists caution that deflation can emerge suddenly once demand weakens.
Economist David Rosenberg has warned that structural forces such as an aging population, slower immigration, and rising tariffs could trigger a “deflationary shock.”
Meanwhile, Robin Brooks, a senior fellow at the Brookings Institution, notes that deflation is already visible in China and parts of the Eurozone, raising the possibility that the U.S. could be next.