Fed's Last Hike This Time? Bond Traders Raise Bets — But Also Hedge Against Dovish Outcomes

With widespread anticipation that the Federal Reserve will dial down its rate hike pace at its Feb. 1 policy meeting, options traders are reportedly taking bets that will gain if investors scale back expectations of more tightening in the future while also hedging against dovish results.

Already, close to half a percentage point of rate cuts have been factored in for the second half of the year, reported Bloomberg.

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Over the last week, the swaps market has been factoring in around 48 basis points of rate hikes over the next two Fed policy meetings, the report added. That implies a small possibility that if the central bank hikes its benchmark rate by 25 bps next week, it could be its final move in a tightening cycle, it said.

The report highlighted an example of a dovish trade seen in the options market where there has been a buildup of a $40 million position, which would gain from around 25 basis points of rate-hike premium being priced out of September 2023 futures.

Treasury Futures: Even the Treasury futures market is indicating this could be the peak of the central bank’s rate hike cycle. Net-short leveraged positions in 10-year Treasury futures by hedge funds have reportedly grown to the largest levels since 2019, while net-long positions taken by institutional investors have risen to record highs. 

This level of contrarian positions by these classes was last seen in late 2018 when the Federal Reserve’s rate tightening cycle was about to reach its peak.

Some experts have voiced contrarian opinions on the rate hike path. Allianz chief economic adviser and economist Mohamed El-Erian reportedly said he is among a small group of people who think the Federal Reserve should not downshift to 25 basis points and stick to a 50 bps rate hike.

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