A research report by Goldman Sachs recently pointed out that the financial market is overly optimistic about the Fed's interest rate cut next year, which gives option traders the opportunity to make profits on their own.
Strategists, including Praveen Korpaty, wrote in their latest report that the market expects the Federal Reserve to cut interest rates by 125 basis points over the next 12 months, with a 50 basis point cut by the end of June (indicating that the US economy is on the brink of recession), which is much more aggressive than Goldman Sachs' own prediction. The bank believes that it will only cut interest rates once in 2024, by a 25 basis point margin.
They said, "The market is approaching the limit of reasonable pricing without considering the possibility of a recent economic recession."
Goldman Sachs strategist suggests selling the SOFR 95.25 call option due in June 2024, shorting the bet on accelerating interest rate cuts in the early stages. SOFR options are linked to secured overnight financing rates, which closely track market expectations of the Federal Reserve's policy path. The option will expire on June 14th next year, two days after the central bank's policy statement in June.
In recent trading days, traders have been increasing their pricing for next year's interest rate cut in the futures, options, and spot markets. The data released by the Commodity Futures Trading Commission last Friday showed that the leveraged net position of SOFR futures has reached a new high.
In addition, there has been a bet in the options market on a rate cut of up to 250 basis points before September, which is about 150 basis points higher than the current pricing in the swap market.
Goldman Sachs economists only expect the Federal Reserve to cut interest rates once in 2024, most likely in the fourth quarter. However, the expectations of major Wall Street banks vary greatly, such as UBS, which is expected to cut interest rates multiple times.
According to the CME Federal Reserve observation tool, as of the time of writing, traders believe that a five time rate cut by the end of 2024 is the most likely scenario.
However, the Goldman Sachs Koreaty team believes that even if the Fed's rate cuts exceed Goldman Sachs economists' expectations, the current expected five rate cuts are unlikely to occur.