The market may be pricing more Fed hikes, but parts of the rates market are starting to hedge the exact opposite.
Here, I am referring to SOFR options.
If you’re not familiar with SOFR, it stands for the Secured Overnight Financing Rate. Basically, it measures the cost of borrowing cash overnight against US Treasuries and is v closely tied to the Fed’s policy rate.
SOFR futures move higher when expected interest rates move lower, so traders use SOFR calls to hedge against a less aggressive Fed and that positioning is becoming pretty noticable.
Open interest in March 2027 SOFR calls has gone up to around 2.7 million contracts and is about 1 million more than puts.
Yes, open interest alone cannot tell us exactly why every trader holds a position, but it does show there is exposure sitting on the lower rates side of the market.
Some trades have gone considerably further.
There is one trade thats targeting a SOFR rate around 3% in 2027. For that to happen, the Fed would probably have to move from hiking to cutting relatively quickly which is a very, very a different outcome from what the market is currently pricing (SOFR \~4.5%)
This also feeds into my broader thesis that equities could see another move higher once we get through the September headwinds.
But... there is one very important question. If rates start moving materially lower, why are they falling?
If inflation is cooling and the market simply got too hawkish, that is one thing.
If growth is deteriorating rapidly, that is something quite different.
And then there is the more interesting possibility I have been discussing recently - some form of policy intervention, whether through the PPT or increasingly aggressive Treasury liquidity operations.