Traders are Оverwhelmingly Betting on a Rate Cut in December

Investors are heavily betting that the Federal Reserve will cut interest rates at its next meeting next month, removing the doubts that just a week ago tilted the odds against such a move. This sets the stage for potential gains in U.S. stocks, as lower rates typically support the markets.

The number of new positions in futures contracts tied to the central bank’s key interest rate has risen significantly over the past three trading sessions. Last week, the January contract recorded consecutive record daily volumes. Market pricing now signals roughly an 80% probability of a quarter-point cut at the December Fed meeting, compared to just 30% a few days ago.

The shift in rate expectations began after the delayed September employment data, which showed a mixed picture of the labor market. Pressure intensified on Friday when New York Fed President John Williams signaled that he sees room for a rate cut in the near future amid labor market weakness.

“The Fed is very divided, but it seems that supporters of lower rates outnumber the opponents,” commented Tracy Chen, portfolio manager at Brandywine Global Investment Management.

This week, San Francisco Fed President Mary Daly backed a rate cut at the next meeting, while Board member Stephen Miran reiterated his case for larger reductions, despite inflation remaining persistently above the central bank’s target.

According to Societe Generale strategist Subadra Rajappa, Fed Chair Jerome Powell and his allies on the rate-setting committee are “in favor of a cut,” despite resistance from other officials more concerned about inflation. Given recent weak economic data, including labor market figures, Powell is expected to be able to persuade the rest of the committee.

Expectations for lower rates are also reflected in the equity market, where JPMorgan’s client survey shows investors increasing long positions in rate-sensitive companies. On Tuesday, tech and growth stocks rose as news of a potential rate cut boosted risk appetite.

It is common for Fed officials to guide Wall Street ahead of meetings to avoid surprises. Only three times over the past two-plus years—covering 20 Fed meetings—have traders failed to fully price in the expected outcome immediately before the decision.

The total number of new long positions in January federal funds futures has reached around 275,000 contracts since Thursday. The contract rose from 96.18 on Thursday to 96.35 on Monday, indicating the addition of new longs and reflecting growing investor confidence in equities.

“The market largely interpreted Williams’ comments as a move by Powell, so to speak,” said Blake Gwinn, head of U.S. rates strategy at RBC Capital Markets. “The data this week also tilted in the same direction.”

Although most Wall Street strategists now expect a December cut, not all are as convinced as the traders. Last week, Morgan Stanley withdrew its forecast for Fed easing, and JPMorgan Chase & Co. also leans toward holding rates steady, though December remains very much in focus.

“We continue to expect the Fed to cut rates in December, but beyond that, the outlook is less clear,” said Tiffany Wilding, economist at Pacific Investment Management Co. “Overall, the economy has performed remarkably well in terms of growth this year, but there are still labor market risks, and inflation appears around 3%, clearly above target.”

For the week ending November 24, investors’ long positions in equities increased by 4 percentage points, reaching the highest level since April, while short positions decreased by 1 percentage point. This pushed net long positions to their highest level since October 2010.

A Look at Recent Positioning Indicators

JPMorgan Survey
For the week ending November 24, investors’ long positions increased by 4 percentage points, reaching the highest level since April, while short positions fell by 1 percentage point. This pushed net long positions to their highest level since October 2010.

New Risk Move in SOFR Options

In SOFR options maturing in June 2026, open interest has increased at the 96.25 strike, primarily due to a significant build-up in positions through Dec25 call options over the past week.

This strike is being used in various structures aimed at hedging around the expected 25-basis-point rate cut at the December FOMC meeting, including:

• SFRZ5 96.125/96.25 call spreads
• SFRZ5 96.25/96.3125 call spreads

Demand continues for SFRZ5 96.1875/96.25/96.3125/96.375 call condors, and SFRZ5 96.1875/96.25 call spreads were also popular over the last week.

Source: Bloomberg Terminal