From SOFR options to bond market tilt: Traders frantically hedge against "Federal Reserve pivot" with a potential 50 basis points aggressive easing in September

According to Zhitong Finance APP, signs of weakness are emerging in the U.S. economy, providing a basis for the Federal Reserve to respond to Trump's call for interest rate cuts, as the bond market is increasing bets on rate cuts within the year. SOFR options tracking monetary policy show that investors are positioning for the possibility of rate cuts in all three remaining meetings, expecting a cumulative reduction of 75 basis points by 2025, with some funds even betting on a direct 50 basis point cut in the September meeting.

The non-farm employment data for July released last week was weaker than expected, coupled with a report on Tuesday indicating stagnation in the service sector, further reinforcing market expectations that the Federal Reserve will cut rates to support the economy. Although Federal Reserve officials had previously not adopted Trump's call for rate cuts, TD Securities strategist Molly Brooks pointed out that there is still a lot of data to observe before the September meeting, and a single indicator is unlikely to change the policy framework.

Market pricing has reflected a warming expectation of rate cuts: the easing extent shown by swap trading has expanded from 30 basis points before the non-farm report to 60 basis points, and the yield on 10-year U.S. Treasuries has also fallen from last month's high of 4.49% to 4.20%.

Figure 1

Dan Carter, a consultant at Ford Washington, believes that in the context of slowing economic growth and easing inflation (excluding tariff factors), yields may continue to trend downward in the coming months.

Bullish sentiment in the spot market is heating up, with a JPMorgan client survey showing that long positions in U.S. Treasuries have risen to their highest level since April. Meanwhile, there are also signals of a policy shift within the Federal Reserve: San Francisco Fed President Mary Daly has clearly stated that "the time for rate cuts has come," and governors Waller and Bowman voted against maintaining rates at the July meeting, advocating for a 25 basis point cut.

Here is an overview of the latest positioning indicators in the interest rate market:

JPMorgan client positions: As of the week ending August 4, clients raised their long positions in U.S. Treasuries by 5 percentage points in one go, bringing the total to the highest level since April 14; net longs also refreshed the peak from July 7, with a weekly increase being the largest since the end of March.

Figure 2

Most active SOFR options contracts: Over the past seven days, among the SOFR options expiring in September, December, and March of the following year, the 95.75 strike price saw the most significant increase in positions. New funds include a put condor spread with expirations on December 25 at 96.375/96.25/95.875/95.75, a put fly on SFRZ5 (3-month SOFR futures contract expiring in December 2025) at 95.875/95.75/95.625, and large purchases of a 95.875/95.75 1×2 put spread. A put spread at the 95.6875 strike price has also seen significant positioning At the same time, the position with an execution price of 95.375 was significantly closed through put options for December and March.

Figure 3

SOFR options heatmap: 95.625 remains the most popular point among the three expiration dates in September, December, and March, with the largest risk exposure for September and December put options at this price level; 95.75 and 95.875 are also actively traded, with the September 25 put option appearing most frequently. The latest dynamics show that funds are continuously buying SFRZ5 95.875/95.75/95.625 put options. Following Friday's employment report, the demand for hedging against further interest rate declines has increased, with some positions directly betting on a 50 basis point rate cut at the September meeting.

Figure 4

U.S. Treasury options risk skew: After the data was released on Friday, the skew of U.S. Treasury options shifted to bullish across the board, paying a premium for upside protection, with the expansion of long-term bullish skew reaching its largest since April.

Figure 5

CFTC futures positions: As of July 29 (the day before the Federal Reserve's interest rate decision), hedge funds significantly increased their net short positions in 10-year Treasury futures, while asset management companies increased their net long positions in 10-year and longer-dated contracts, showing a significant divergence between the two sides.

Figure 6

The current market focus is on the September meeting, with some SOFR options trading indicating that investors are preparing for a potential significant rate cut through upside hedging strategies. As economic data continues to signal a slowdown, the interaction between policy shifts and market bets will become a key variable in the future