Market Hints at Three More Rate Hikes, but Traders Hedge Against Expectations

The interest-rate swap market indicates that the Federal Reserve will raise rates by 75 basis points by June next year, equivalent to three 25-basis-point hikes. However, some traders are hedging against the possibility that the Fed's ultimate rate hike may fall short of this level.

Data show that demand for call options on SOFR futures expiring in March next year has risen over the past week, reflecting growing market interest in hedging against a less aggressive tightening of policy. SOFR is a key benchmark reflecting the cost of overnight borrowing by institutions collateralized by U.S. Treasury securities.

Traders use SOFR options to bet on the future trajectory of short-term interest rates. The price of SOFR futures moves in the opposite direction to the rate itself: a rise in prices signals that the market expects interest rates to decline.

Certain investors and strategists believe that the market has already fully priced in expectations of three more rate hikes, and are inclined to take the opposite view. They point out that four rate hikes within a year would be a rather aggressive response to the current economic backdrop and could trigger substantial knock-on effects across the macroeconomy.