Concerns about rising inflation, and the Fed hiking rates to contain it, have reversed rather dramatically.

As Bloomberg's Edward Bolingbroke observes, after months of consensus trades that the Fed's easing cycle will end in 2026, traders in US futures and options markets are suddenly piling on bets that the Fed will continue cutting rates well into next year instead of raising them.

As shown below, the key spread linked to the SOFR (the Secured Overnight Financing Rate) which track expected Fed policy,have becoming deeply inverted in the past week, a sign that traders are starting to price a more prolonged easing cycle.The 12-month December 2026 to 2027 SOFR spread dropped into negative on Friday withthe inversion deepening on Tuesday to minus 8 basis points, in a sign that investors have flipped from pricing hikes in 2027 to pricing cuts.

In the SOFR options market a similar dovish theme is observed for trades that are hedging (orencouraging,depending on how one views the role of options) the prospect of multiple rate cuts this year. Those trades picked-up again on Tuesdaywith one position that’s looking to hedge for the policy rate falling to as low as 2% by the end of the year growing in size.

Open interest in the December 98.00 calls ballooned to more than 400,000 this week. A record amount of just over 150,000 calls traded in the 12-month spread over Monday’s session, while the total open interest of SOFR Dec26 98.00 calls soared above 400,000 amid the trading frenzy. For context, the swaps market is currently pricing a Fed rate of around 3.1% - or just over two 25-basis point cuts - by year-end, some 110 basis points above the options strike price.

Until mid-February, traders were betting that the central bank would resume hiking rates in 2027 after two quarter-point reductions by the end of this year. However, the ongoing wipeout of Software stocks and the growing debate around the impact of artificial intelligence on the labor market is leading them to reassess this outlook. On Tuesday, Fed Governor Lisa Cook warned that the central bank may not be able to counter rising unemployment driven by the adoption of AI.

Which, of course, leaves fiscal policy as the only recourse to provide a safety net for the millions of soon-to-be-unemployed white collar workers displaced by chatbots. And, fiscal policy needs to be funded by brrrr, which means sooner or later the Fed will have to print again, just as we said back in 2024 in a 22-word tweet which effectively previewed and summarized that 7000 word Citrini essay far more eloquently.

Market pricing so much AI success, it will need to leave about 100 million people without a job.Bring on the UBI

But we'll cross that money printer when we get to it: for now, what's important is that the flattening move in SOFR spreads accelerated sharply since the end of last week, just as AI disruption fears took a toll on a swath of stocks, setting off a rally in long-dated Treasuries and raising recession odds among multiple brokers..

Gennadiy Goldberg, head of US rates strategy at TD Securities, told Bloomberg that “there has certainly been a bit of repricing for lower yields after the Fed hits terminal, with the market penciling in a more gradual drift higher in yields."

Source: ZeroHedge News