(Bloomberg) - Traders focused on options are increasingly pricing out expectations for any Federal Reserve interest rate cuts in 2026, making wagers instead that would pay off if the central bank stays on hold all year.
The theme has been in place since at least Friday, when the latest US employment data showed an unexpected drop in the jobless rate. That all but erased the chances of a rate cut at this month’s Fed policy meeting, as measured by market prices, and prompted a growing camp of traders to push back their timing for reductions in the months ahead.
A steadying labor market gives central bankers less reason to keep cutting rates after three quarter-point reductions last year, especially with inflation still running ahead of the Fed’s target.
“We’ve got a kind of a muddle in the jobs picture, then we’ve got an inflation problem,” said David Robin, an interest-rate strategist at TJM Institutional Services LLC. “The probability from a data perspective that the Fed will stay on hold at least through March has increased, and as every meeting falls off the calendar, the probability that the Fed stays on hold becomes more likely.”
Treasuries gained slightly, pushing the 10-year yield 3 basis points lower to 4.15% in London trading. Even as the swaps market still shows expectations for a half point of cuts in 2026, recent options flow linked to the Secured Overnight Financing Rate, or SOFR, which is closely linked to the Fed’s short-term benchmark, is telling a more hawkish story.
The bulk of new options positions have been centered around March and June, hedging a scenario of continued delays in the Fed’s next quarter-point move. Other positions targeting further out the futures strip stand to benefit from a Fed-on-hold stance in 2026, with its target remaining within the current 3.5%-3.75% band through year-end.
“Whether the market believes the Fed is on hold or not — whether the probability is 5%, 10%, 20% — these trades are cheap, and if you’re a disciplined risk manager, you want those,” TJM’s Robin said.
Some strategists are coming around to a similar view. Following Friday’s payrolls data, economists and strategists at JPMorgan Chase & Co. said they no longer see a rate cut this year and instead predict a hike in 2027. A month ago, HSBC Securities forecast no Fed rate moves at all through 2027.
The shifting sentiment in options comes against a backdrop of heightened tensions between the Trump administration and central bank leadership under Chair Jerome Powell, who on Sunday revealed a Justice Department criminal inquiry against him that he says is politically motivated.
The move revived concerns around central bank independence, and triggered a backlash among central bankers, investors and lawmakers who came to Powell’s defense. It also has cooled sentiment in the cash market for Treasuries.
A JPMorgan survey of positioning changes by clients during the week ended Jan. 12, showed short positions rising 4 by percentage points and longs increasing by 3 percentage points. The result is the least net longs since October 2024 and the most outright shorts since Oct. 6 last year.
Here’s a rundown of the latest positioning indicators across the rates market:
SOFR Options
In SOFR options across Mar26, Jun26 and Sep26 tenors, there has been considerable demand over the past week to hedge downside via Mar26 contracts. The 96.375 strike has been active via popular downside flows, including buyers of the SFRH6 96.375/96.3125 put spreads and SFRH6 96.43759/96.375/96.3125 put trees. Other flows seeing rising open interest have included buyers of the SFRM6 96.5625/96.50/96.4375 put trees.
The broader open-interest picture in SOFR options out to the Sep26 tenor show the 96.50 strike is still the most elevated in terms of risk held by traders, featuring a large amount of Mar26 calls and puts positioning. There remains a large amount of risk in the Mar26 96.375 and 96.3125 puts also, while the 96.75 strike continues to hold a sizable amount of Mar26 and Jun26 calls.
Treasury Options Premium
The premium paid to hedge Treasuries risk over the past week has drifted toward favoring calls in the front end out to the 10-year sector, while remaining close to neutral in long-bond options. The subtle move reflects investors paying a slightly higher premium to hedge a bond market rally in 2-year, 5-year and 10-year note futures versus put protection, or higher yields.
By Edward Bolingbroke
With assistance from Elizabeth Stanton and Naomi Tajitsu
