A £1.5 million gamble aiming for a £20 million return! Will the "inflation-ignoring" interest rate cut bet spread from Great Britain to America?
A small number of traders in the UK options market are betting that the Bank of England will significantly cut interest rates, despite inflation rising to an 18-month high. Their bets could yield returns of up to 1000% if the benchmark rate drops to 3.5%. The current benchmark rate is 4.25%, and traders need it to fall to at least 3.75% to avoid losses. Market expectations for rate cuts have been significantly lowered, even though the Governor of the Bank of England has hinted at a possible substantial reduction in the policy rate
According to the Zhitong Finance APP, a small group of aggressive traders in the UK options market have placed heavy bets, wagering that if the Bank of England ignores the inflation rate, which has risen to an 18-month high, and implements more rate cuts beyond the current market pricing this year, their massive bets could yield returns of over 1000%. If the Bank of England's benchmark interest rate drops to 3.5% this year, bets linked to the pound's overnight index average rate could yield nearly £20 million from an initial expenditure of about £1.5 million.
The current benchmark policy rate of the Bank of England is 4.25%, and policymakers need to lower the benchmark rate to at least 3.75% for these aggressive betting traders to avoid significant losses.
On Thursday, the market bought options strategies linked to the pound's overnight index average (SONIA) — this rate is seen as a barometer of the UK's benchmark policy rate. If the benchmark rate drops to 3.5% by the end of the year (25 basis points lower than the current implied level in the money market), these positions could generate nearly £20 million in super returns from an initial cost of about £1.5 million.
Such bets could yield abnormally high returns due to their logic of "going against the trend." Following stronger-than-expected UK inflation and wage growth data, the market has significantly lowered its expectations for the Bank of England's monetary policy easing this week.
Swap contracts linked to policy meeting dates no longer indicate that there will be three more rate cuts this year, whereas earlier this week, there was still a 20% chance of such cuts. In May of this year, the market had a similar "high-stakes bet": the target rate was even set at 3.25%.
Despite the latest inflation data exceeding expectations, Bank of England Governor Andrew Bailey's comments earlier this week still left the market hopeful for aggressive rate cuts. He hinted that if the UK labor market deteriorates faster than the Bank of England predicts, the policy rate could be significantly lowered.
Loss Risk Needs Attention
To avoid any of these traders facing substantial losses, the Bank of England must at least lower the benchmark rate to 3.75%. Options trading is traditionally conducted anonymously, making it difficult to determine who or which institutions are behind these trades.
Meanwhile, as the latest economic data shows that tariff costs are being passed on to prices, concerns about inflation in the US have surged, leading to a significant cooling of rate cut bets. However, some analysts suggest that as SONIA options become a gambling ground, traders' bets on the Bank of England's "inflation-ignoring" aggressive rate cuts may spread to US Treasury futures and the US interest rate futures market.
Industry analysts are concerned that the signals from traders betting on the Bank of England's "inflation-ignoring" rate cuts could transmit to the US interest rate futures market, leading to increasingly "irrational" pricing for rate cuts, and may also cause the US interest rate futures market to favor anchoring the labor market to price the Federal Reserve's rate cut path, rather than core CPI and PCE inflation Traders have significantly lowered the probability of the Federal Reserve cutting interest rates twice this year to 75%, while just a week ago, the market had fully priced in a half-percentage point rate cut, and even at one point fully priced in a dovish expectation of three rate cuts totaling 75 basis points this year.
The "CME FedWatch Tool" shows that traders in the interest rate futures market generally believe that the Federal Reserve will cut rates as early as September, with a higher likelihood of action in October (probability over 50%), and are betting that the Federal Reserve may only cut rates once this year, possibly by 25 or 50 basis points, rather than the previously anticipated three cuts totaling 75 basis points before July
