Traders Reap Huge Profit on Fed Rate-Cut Bets Made Weeks Ago

(Bloomberg) -- Traders who in July made what appeared to be long-shot bets on supersized Federal Reserve interest-rate cuts are now in line to reap huge profits after markets lurched their way.

In a big shift, the market is now pricing in a half-point rate cut at central bankers’ next policy meeting in September. Other activity in fed funds futures is signaling that traders also are starting to wager on an intra-meeting move before the next scheduled policy announcement.

“Investor sentiment has shifted decidedly in favor of economic angst over optimism,” Ian Lyngen, head of rates strategy at BMO Capital Markets, wrote in a note Monday.

Traders who got in ahead of this swing in sentiment, when the price of the futures contract was relatively low, are now well in the money and stand to make multiples on their investment, assuming they haven’t cashed out yet.

Just weeks ago, fed funds futures were pricing in a conventional quarter-point cut at US central bankers’ next policy meeting in September on the view that a gradual of easing would be sufficient to keep the economy on course. That framework has been shattered as data showing slowing in jobs growth and other key areas has sparked concern that the Fed may have left rates too high for too long, increasing the risk of recession.

Among the winning wagers involving October fed funds futures, a position of 50,000 futures was taken on July 12 at a level of 94.920. The contract hit a high of 95.325 earlier in Monday’s session, indicating a profit of roughly 40.5 basis points — or about $85 million on the wager, according to a Bloomberg position duration analysis.

Traders are showing no signs of letting up in putting money to work on aggressive easing plays. Friday’s volumes in the fed funds contract expiring Oct. 31 clicked in at a record of almost 400,000, well above the current 132,000 15-day moving average.

Buying in fed funds futures ramped-up after economists at Citigroup Inc. changed their Fed forecast to reflect half-point rate cuts at both the September and November policy meetings and a quarter-point cut in December. The activity in the aftermath included a 18,000 block buy at 95.115, almost 20 basis points higher in price than the trades in July.

Meanwhile, open interest — or the amount of risk held by investors — rose for a ninth straight day in the US 10-year futures contract on Friday, as traders continued to amass long positions in Treasuries.