Derivatives indicate lower Fed interest rates and stronger EURUSD in 2024

At the end of the year, it is common to summarize the results. This also applies to currency market instruments.

Let's take a brief look at the path taken by the most popular EURUSD currency pair.

During the Fed's policy tightening cycle, the US dollar was actively strengthening in the second half of 2021 and almost all of 2022. After that, against the background of declining inflation indicators, there was a rebound in early 2023 and the pair went into a wide flat.

What to expect in 2024?

It is worth paying attention to the derivatives market, which has a certain predictive value.

The wagers, made via so-called SOFR options that reference the secured overnight financing rate, will start to pay off if the Fed cuts its benchmark rate to around 3% by next September. The premium paid on the wager is about $13 million and Bloomberg analysis of options scenarios shows it could yield $200 million if SOFR drops to 2%.

This trade is evidence of increased activity in SOFR derivatives, which closely corresponds to expectations for future central bank policy. While some previous trades have since been closed out, traders are now pushing these wagers on a dovish reversal deeper into next year.

Traders are revising their bets on a significant Fed rate cut and are targeting multiple policy easing measures.

Hedge funds increased net long positions in SOFR futures to a new record high last week, according to the latest futures positioning data released by the Commodity Futures Trading Commission on Monday.

Traders are now no longer thinking about further hikes, and the consensus is that the Fed will cut rates, but not by as much as 250 basis points. Swaps data indicate that investors are forecasting rate cuts of about 95 basis points from the January meeting through the end of next year.

The overall recommendation is to buy EURUSD with a long-term target at 1.155.

Profit or loss should be taken at the end of the third quarter of 2024.