By Jamie McGeever

ORLANDO FL (Reuters). – Wall Street’s slump and recovery suggest that a recession could be coming. The Federal Reserve will likely slow down its tightening cycles sooner than anticipated and allow for rate reductions later in next year.

According to the most recent Commodity Futures Trading Commission report, this is exactly what hedge funds are betting on.

The data for the week ending May 17, show that speculators reduced their net short position within three-month Secured Overnight Finance Rate (SOFR), contracts to almost zero in two months and kept a net long position at 30-day fed funds futures.

This shift in SOFR futures positioning, particularly in the light of wider trends in the market, is the most telling indicator of traders’ opinions on U.S. interest rate path over the coming years.

From 460,721 last week, funds saw their net short of three months to 388.207 contract. This is the net deficit in the last seven weeks and a significant decrease from the previous record of over 600,000. contracts a month earlier. 417b4cb4-4628-40b6-9928-75f3119bf3863

This shift could be attributed almost exclusively to an increase in long positions and not short covering. It suggests that traders have begun to consider easing the next year instead of aggressive tightening this year.

An implied yield is the expectation that an asset will drop in price. A long position, on the other hand, is expected to rise. Implied yields in rates fall when prices rise and go up when they fall.

Officials at the Fed have stated that they will continue to tighten policy until inflation targets are met. This is despite economic pain. The SOFR market is seeing more funds and traders putting their eggs into that “pain basket”. affb6724-499a-449b-b17e-98651e870c8d1 ea0d747d-cd45-46c7-87c1-038b6d9fa9a92

RATE CUTS SEEN IN THE NEXT YR

First, the implied rates for next-year have dropped sharply. The Fed Funds Rate for the June 2023 Contract is currently at 3%. That’s almost half the point off the May 4th high, the date of Fed’s 50 basis point rate increase.

Second, the Fed’s expected tightening cycle length has dramatically decreased. A few months back traders expected the Fed’s “terminal” rate to be attained in September 2019. This has changed to June but March is now on the table.

The December 2023 SOFR Futures implied rate has dropped to 2.80%. It was the lowest it’s been in 2 months. This is a significant improvement on the June peak rate and implies that there’s a 80% chance of the Fed reducing rates during the second half next year.

James Bullard of the St Louis Fed, who is in favor of raising rates to 3.5%, stated that the Fed may cut them next year if inflation remains under control.

Fed officials, economists, and the majority of economists continue to predict no recession. However, the Fed and most economists still believe there will not be a recession. Wall Street is experiencing turmoil and Citi’s U.S. Economic Surprises index has fallen to a five-month low.

“We believe that Fed policy’s tightening financial environment will cause a recession in 2023.” Deutsche Bank Analysts from the ETR wrote Friday.

Wells Fargo (NYSE: ) Deutsche and its research arm joined Deutsche last week in anticipating the U.S. downturn. But it happened earlier this year. 51ba9e45-cf9f-4651-99e4-67514e57e11d4

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(The author is a columnist at Reuters.

(By Jamie McGeever. Editing by Sam Holmes.