Traders are betting that the Federal Reserve may be forced to raise interest rates in the next few weeks

On March 27, bond traders panicked by the possible escalation of the conflict in Iran and were seeking to hedge against the worst-case consequences of the war-that is, the Federal Reserve could be forced to raise interest rates in the coming weeks. In the options market that tracks Fed policy, demand has emerged for bets tied to the Guaranteed Overnight Financing Rate (SOFR), bets that correspond to a scenario where interest rates could be raised as early as two weeks. These deals will benefit if the bond market significantly raises interest rate increases expectations before the Fed's policy meeting on April 29. This surge in demand for hedging against emergency interest rate hikes marks a sharp reversal in market sentiment. Just a month ago, the market was expecting up to three 25 basis point rate cuts by the end of this year. Since the war broke out on February 28, swaps market traders have begun to calculate the probability of a rate hike by about 50% before December, exposing short-term U.S. debt to the risk of further repricing. Jeff Schuh, head of interest rates at Constitution Capital, said that while the latest bets do not reflect the market's benchmark scenario, they do signal growing concerns that rapidly rising inflation will put investors who have made more debt in recent months at risk. Shuh said traders have closed a large number of long positions in U.S. bond futures as soaring oil prices have raised concerns that inflation will rise again. The sell-off of SOFR futures and the upward trend of the entire U.S. bond yield curve caught many large funds off guard. He pointed out that for funds seeking to manage interest rate risk, such transactions "make the risk of bursting appear more manageable 90% of the time and are a cheap stopgap measure."