This past Thursday, the Federal Reserve is widely anticipated to announce a continued reduction in interest rates by 25 basis points, signaling a completion of its easing journey for the year 2024 with a "triple cut." Speculation around the Fed's direction for rates has become a hot topic among market participantsMany institutions on Wall Street currently predict that the Fed will likely slow down its pace of easing next year, moving toward a more cautious and gradual approach.

Recently, officials at the Federal Reserve indicated that this week’s rate cut may signify the end of the first stage of cutting ratesDuring this initial phase, borrowing costs remained elevated, leading the officials to set a relatively low threshold for cutting ratesMoreover, they have been waiting for months to ensure that inflation rates are not just near their target but also showing a downward trend.

Last week, economists surveyed by Reuters predicted that the Fed would only lower rates three more times in the following year, with each cut being 25 basis points.

Robert Tipp, chief investment strategist at PGIM Fixed Income, expressed, "Market rates may stay close to current levels

While the Fed might continue to lower rates, it certainly won't be at the pace of cutting rates at each meeting as seen in some quarters over the past several months."

The relatively hawkish expectation among market analysts can be traced back to internal Federal Reserve discussionsIf the U.Seconomy continues to grow at a steady pace, there will be less justification for further cutsAdditionally, the proposed reforms in trade, immigration, regulatory measures, and tax policies may reshape economic growth, employment, and inflation prospects over the next few years.

Looking at the indicators that typically inform monetary policy decisions, inflation and employment data have recently shown some nuanceFor instance, the inflation rate in the U.Sexperienced a modest increase from 2.6% in October to 2.7% in November, exceeding the Federal Reserve’s target of 2%. Furthermore, the U.S

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non-farm payrolls added 227,000 jobs in November, surpassing expectations of 220,000. The average hourly earnings also grew, showcasing a year-on-year increase of 4% and a month-on-month increase of 0.4%, outstripping previous expectations of 3.9% and 0.3% respectively.

In other words, the Fed appears to have reasonable grounds to moderate the pace of interest rate cutsEven if the Fed opts for a 25-basis-point cut, interest rates would still be above most estimates of neutral rates, which typically range from approximately 2.5% to 4%. Currently, the Fed's federal funds rate stands at around 4.6%.

Interestingly, amidst this market backdrop, there are rate traders who don’t seem entirely convinced by the prevailing narrativeRecent trading data from options and futures markets reveals that these traders have been ramping up their related bets, anticipating that the ultimate reduction by the Fed next year could be greater than what is currently priced into the market.

In the realm of interest rate options, several traders have recently wagered that the market outlook is overly hawkish, predicting that the Fed will align its actions more closely with its September dot plot forecast—which implies four rate cuts, each of 25 basis points, by 2025, reducing the implied federal funds target rate to 3.375%.

These traders may be considering potential indicators of labor market vulnerability, which could amplify the case for further easing by the Fed

For example, earlier this month, U.STreasury yields saw a brief spike due to unexpected increases in unemployment rates.

Moreover, in options linked to overnight indexed swap rates, particularly sensitive to Fed policy expectations, the current demand has shifted towards dovish structures targeting early 2026 with expiries in early 2024. If the trajectory of the Fed's policy turns out to be more dovish than what the market anticipates, these positions stand to gain.

Simultaneously, traders have been expanding their positions in federal funds futuresOpen interest in contracts maturing in February has soared to record levels, closely associated with the Fed's policy announcements in December and JanuaryRecent capital flows around this timeframe have leaned toward buying, indicating that new bets will benefit from a potential rate cut in December followed by further easing in January.

This month, Morgan Stanley proposed a buy recommendation on February federal funds rate contracts, igniting considerable market activity and significantly boosting bullish sentiment

The bank's strategists pointed out that, given the subtle shifts in the economic landscape and uncertainties surrounding the Fed's monetary policy direction, investors should prepare for a higher likelihood of a 25-basis-point rate cut in JanuaryYet, current market conditions seem to reflect a degree of cautionPresently, the market is pricing in a mere 10% chance of an additional rate cut next month by the Fed, suggesting that most investors still harbor skepticism regarding another significant cut in the short term, possibly due to recent economic data fluctuations that have yet to demonstrate a clear trend sufficient to support a substantial easing of monetary policy.

Regardless, for those who believe that the Federal Reserve will maintain its downward trajectory into January with the potential for four total cuts throughout the year, the critical moment lies just aheadTomorrow morning is poised to be a defining juncture for these "non-mainstream bets," acting as a litmus test for how the market interprets the Fed's forthcoming actions and signaling.