Reverse betting emerges: The Federal Reserve's next move is to raise interest rates rather than cut them

According to the Zhitong Finance APP, the next move of the Federal Reserve will be to raise interest rates, rather than lower them, which is the most optimistic yet also the most uncertain bet among a group of stubborn bond traders. This bet emerged after the strong non-farm payroll report released in the U.S. on January 10, contrasting sharply with Wall Street's consensus that the Federal Reserve will cut rates at least once this year. Although the U.S. December CPI data released last Wednesday reinforced the Fed's dovish stance and led to a retreat in U.S. Treasury yields from multi-year highs, this counter-bet still exists.

According to an analysis at last Friday's close, based on options related to the secured overnight financing rate, traders currently estimate the likelihood of the Federal Reserve raising rates before the end of the year at about 25%. Before the release of the U.S. December CPI data, this probability was as high as 30%. Just over a week ago, the possibility of the Fed raising rates this year was not even considered—60% of options traders bet that the Fed would further cut rates, while another 40% bet that the Fed would pause rate cuts.

Like many things in today's financial markets, this is essentially a bet on the policies that Trump, who is set to become the President of the United States, will implement. It hinges on the view that tariffs and other policies implemented by the new government will trigger a rebound in inflation, forcing the Fed into an awkward turnaround.

Phil Suttle, a former economist at the New York Fed, expects the Fed to raise rates in September. He anticipates that the tariffs and immigration restrictions proposed by Trump will drive up inflation. He added that the U.S. has already begun to see wage levels rise again.

Currently, Phil Suttle's view remains quite extreme. Bond traders have fully priced in the expectation of a 25 basis point rate cut by the Fed this year. They also believe that the likelihood of a second rate cut by the Fed this year is about 50%. However, Roger Hallam, global rates head at Vanguard, stated, "If inflation surprises significantly in the coming months, the market may start to consider the possibility of a rate hike this year."

After the rate decision in December last year, Fed Chairman Jerome Powell told reporters that the Fed is unwilling to let inflation exceed its 2% target. When asked if this meant they could not rule out the possibility of a rate hike in 2025, Powell replied, "In this world, you can't completely rule out anything." But he also added that a rate hike "doesn't seem to be a likely outcome."

While the threshold for a rate hike is high, the Fed has previously changed course rapidly. In 1998, the Fed cut rates three times in quick succession to curb a financial crisis triggered by the Russian debt default and the near-collapse of the hedge fund Long Term Capital Management. Subsequently, the Fed began raising rates in June 1999 to contain inflationary pressures Tim Magnusson, Chief Investment Officer of hedge fund Garda Capital Partners, stated, "What the market needs is for inflation to truly rise—say, for the overall CPI to reach around 3%—to meaningfully price in interest rate hikes." He added, "I think the Federal Reserve is quite comfortable staying put for a while."

Benson Durham, Global Asset Allocation Head at Piper Sandler and former Federal Reserve economist, believes that the pricing of money market options indicates a nearly 10% chance of at least one interest rate hike this year. He noted, "Overall, the market's current view on the risks of rate hikes or cuts seems quite balanced."