The Powell Nomination Effect Cools Down? Traders Bet on the Federal Reserve Cutting Rates Only Two to Three Times This Year

Noticeably, short-term interest rate traders are inching towards a consensus bet: if the Fed only cuts rates two to three times this year, the bet will pay off. Since President Donald Trump nominated Kevin Wash to be the Fed chairman earlier this month, traders have been heavily buying positions betting on a dovish shift in Fed stance. However, ahead of the eagerly anticipated employment market data release on Wednesday, the current bets are slightly conservative. Options flow linked to the Secured Overnight Financing Rate (SOFR) shows strong demand for so-called "hawkish options". SOFR closely tracks the expected path of central bank policy rates, and these options target two scenarios: the Fed cutting rates by 25 basis points two or three times in 2026. At the same time, interest rate swap options markets have also seen similar rate volatility hedging tools in recent weeks. Barclays strategists noted an increase in rate volatility following Wash's nomination, with investors favoring long bond positions. Strategists Amrut Nashikkar, Eveline Dong, and Charley Chau stated in a report, "Investors are seeking bullish duration exposure to cope with a more dovish Fed, but do not expect substantial rate cuts." They pointed out that investors' "target is not more than two to three additional rate cuts". The recent active performance in options markets comes ahead of the key January employment report release. The data is expected to reveal a weakening or stagnant US labor market, which could alter policy expectations. The swap market currently foresees a 30% chance of a third 25 basis point rate cut this year, with the likelihood of two rate cuts before the September meeting almost fully priced in. This has risen from a week ago when the market expected less than 50 basis points of cuts by December. Weaker-than-expected retail sales data on Tuesday further strengthened this momentum towards dovishness. Following the retail data release, US Treasury bonds rose on Tuesday, pushing yields to their lowest level in the past month. Previously speculated to follow Trump's repeated calls for rate cuts after taking over from Chairman Powell, Wash may not be as aggressive in cutting rates due to persistent inflation and some Fed policymakers maintaining a hawkish stance. If confirmed by the Senate, Wash will take office promptly and preside over the June policy meeting. Below is a summary of the latest position indicators in the interest rate market: J.P. Morgan survey In the week ending February 9, client net long positions increased by 4 percentage points, while short positions decreased by 5 percentage points. The result was the largest long position since December last year. SOFR options In SOFR options expiring by September 2026, in the past week, there has been strong demand for call options around the March 2026 expiration, such as the SFRH6 96.4375/96.50/96.5625 and SFRH6 96.375/96.4375/96.50 call option combinations. Additionally, the 96.375 strike price was also present in some put option structures expiring in June 2026 in the past week, such as the SFRM6 96.4375/96.375 2x3 put option spread. One of the highlights of trading in the past week is structures aimed at achieving up to three rate cuts, with the 96.75 strike price active, benefiting from the SFRU6 96.75/97.00/97.25/97.50 call hawkish option and the SFRU6 96.75/96.875/97.125/97.375 broken call hawkish option large buyers. Overall, in options expiring on March 26th, June 26th, and September 26th, the most traded strike price remains at 96.50, holding a large number of open interest contracts for call options expiring on March 26th and June 26th. Demand for the 96.375 strike price has also increased significantly in recent weeks, currently holding a large number of open interest contracts for both call and put options expiring on March 26th, as well as put options expiring on June 26th. SOFR options open interest contracts US Treasury options premium Following a higher put option premium three weeks ago, the risk hedging premium in the US Treasury yield curve has slightly moved closer to call options. However, the volatility has been minimal since the beginning of this month, reflecting a market environment of continued low rates and volatility.