Traders Are Suddenly Betting Heavily On An Imminent Fed Policy Error

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by Tyler Durden
Friday, Aug 13, 2021 - 11:10 AM

Futures markets are currently anticipating a first rate-hike by the end of 2022 (Dec 22 implied around 46bps) and expect rates to be around 1.46% by the first quarter of 2025.

However, a growing number of traders (dramatically growing since this week's CPI/PPI data), are betting on a more extreme tail event to occur away from that consensus.

Bloomberg reports that traders this week have been piling into Eurodollar call options on underlying March 2025 futures that target three-month Libor to fix below 0.5%. These pay off if markets price the Fed keeping its benchmark at its lower bound until then. The options, most importantly, expire in March 2022.

Specifically, the option pays off if markets adjust by March 2022 to expect 3-month Libor below 0.5% in 2025 (as opposed to the current 1.46% we noted above).

Bloomberg suggests a scenario where the Fed ends up holding rates near record lows through to 2025 would probably mean that the global economy fails to recover from the pandemic, resulting in central banks maintaining their ultra-easy policy.

We have another potential scenario that makes more sense...

The fact that the options mature in March 2022 implies traders are betting that the growing calls for tapering The Fed's asset-purchases, which inevitably precedes the raising of rates, will evaporate sooner rather than later.

It would appear the bet is that The Fed announces taper (September/October), and begins tapering, crashes the market, then is forced to about-face its tapering back into moar-QE and thus no rate-hike ever ever again...

We suspect what little shred of credibility The Fed still has will be well and truly curb-stomped by that policy error and who knows what that means for the USDollar's reserve status.

On the other hand, one might argue, this process (taper - crash - un-taper) is exactly what Washington wants in order to ensure The Fed can still monetize the endless debt issuance - hell, it "worked" for Japan, right?

We would never be Japan, we hear you cry? Think again...

The past few days have also seen pockets of buying in options which target negative rates within the next two years...

...another indicator that traders are hedging against a significant delay in the global recovery, or an enormous response to an epic post-taper crash.