The wind has changed! Internal divisions within the Federal Reserve have intensified, and traders are urgently reducing their rate cut bets

According to Zhitong Finance APP, traders are lowering their expectations for the Federal Reserve's interest rate cuts in the coming months, a shift that indicates the mixed messages from Fed officials have influenced expectations for monetary policy.

Options linked to the secured overnight financing rate show that market participants are betting on the Fed cutting rates by only 25 basis points in 2025, and that the so-called neutral rate (the interest rate level that neither stimulates nor suppresses economic growth) is higher than current market expectations. This contrasts sharply with last week when market expectations for a 50 basis point cut by the end of the year were heating up.

Expectations for the neutral rate rose slightly after the Fed's September meeting.

The broader monetary policy views expressed by Fed officials in recent weeks have driven this shift, with traders hedging against scenarios of significant rate cuts and smaller cuts.

Newly appointed Fed Governor Stephen Milan stated this week that policy is still too tight and advocated for a 125 basis point cut in the remaining two Federal Open Market Committee (FOMC) meetings of 2025. Meanwhile, Atlanta Fed President Raphael Bostic said on Tuesday that the Fed needs to remain vigilant against inflation.

At the same time, Fed Chairman Jerome Powell indicated in a speech on Tuesday that both the labor market and inflation outlook face risks, and he did not reveal whether he would support a rate cut at the Fed's next meeting in October.

John Canavan, an analyst at Oxford Economics, stated, "The comments over the past few days have actually reinforced the apparent significant divergence presented in the dot plot." The dot plot shows policymakers' forecasts for the direction of the federal funds rate over the next few years.

Last week, the Fed lowered the policy rate to a range of 4% to 4.25%, marking the first rate cut by the agency this year.

In the days following the meeting, a significant amount of trading targeted rate changes that were below the approximately two 25 basis point changes priced in by the current swap market. Over the longer term, the options market has also seen trades suggesting a neutral rate close to 3%.

The interest rate swap market currently expects the neutral rate to be around 2.95% and anticipates a total cut of about 40 basis points in the remaining two meetings this year.

A JP Morgan survey of U.S. Treasury clients showed that as of the week ending September 22, investor short positions rose by 4 percentage points to the highest level since early February. Long positions also increased, while neutral positions fell by 7 percentage points.

Investor short positions in U.S. Treasuries have risen to the highest level since early February.