Short-term interest rate traders are increasingly converging on a consensus bet that would pay off if the Federal Reserve delivers only two to three rate cuts this year. Since President Donald Trump nominated Kevin Warsh for Fed chair earlier this month, traders had aggressively built positions anticipating a more dovish policy shift. However, ahead of Wednesday’s highly anticipated labor market data, those bets have now turned more cautious.

Options flow tied to the Secured Overnight Financing Rate (SOFR)—which closely tracks the expected path of the central bank’s policy rate—shows strong demand for so-called "hawkish options." These options target one of two scenarios: the Fed cutting rates by 25 basis points either two or three times by 2026. A similar hedging activity has been observed in the interest rate swaptions market over recent weeks.

Barclays strategists noted that interest rate volatility picked up following Warsh’s nomination, with investors favoring long-duration positions. In a report, strategists Amrut Nashikkar, Eveline Dong, and Charley Chau stated, “Investors are seeking bullish duration exposure to position for a more dovish Fed, but not anticipating aggressive rate cuts.” They highlighted that investors are “targeting no more than two to three additional cuts.”

The recent options activity comes ahead of key January employment figures, expected to reveal whether the U.S. labor market is weakening or stagnating—a development that could reshape policy expectations. Swap markets currently price in about a 30% chance of a third 25-basis-point cut this year, while two cuts by the September meeting are almost fully priced in. This marks an increase from a week ago, when markets anticipated less than 50 basis points of easing by December.

Tuesday’s weaker-than-expected retail sales data added momentum to this dovish shift. Following the report, Treasury prices climbed, pushing yields to their lowest levels in a month. Markets had previously speculated that Warsh, if confirmed to succeed Chair Powell, would heed Trump’s repeated calls for rate cuts. However, with inflation remaining stubborn and some Fed officials retaining a hawkish stance, Warsh may not pursue aggressive easing.

If confirmed by the Senate, Warsh would take office in time to chair the June policy meeting.

Below is a summary of recent positioning indicators in rates markets:

**J.P. Morgan Survey** In the week ending February 9, client net long positions rose by 4 percentage points, while short positions fell by 5 points. The result is the largest net long position since December.

**SOFR Options** In SOFR options expiring through September 2026, demand has been strong for upside structures around the March 2026 expiry—such as call spreads with strikes at SFRH6 96.4375/96.50/96.5625 and SFRH6 96.375/96.4375/96.50. The 96.375 strike also appeared in put structures for June 2026 expiries, including the SFRM6 96.4375/96.375 2x3 put spread.

One notable trade last week involved structures targeting up to three cuts, with the 96.75 strike active due to large buyers of SFRU6 96.75/97.00/97.25/97.50 call condors and SFRU6 96.75/96.875/97.125/97.375 broken call condors.

Overall, across options expiring in March, June, and September 2026, the 96.50 strike remained the most traded, holding significant open interest in calls for March and June expiries. Demand for the 96.375 strike has also surged recently, with substantial open interest in March calls and puts, as well as June puts.

**Treasury Options Skew** After reflecting higher put premiums three weeks ago, the cost of hedging risk in the U.S. Treasury yield curve has tilted slightly toward calls. However, the shift has been minimal since the start of the month, reflecting a low-rate, low-volatility environment.