There were no major surprises at the September FOMC meeting, as the Federal Reserve cut rates by 25 basis points. Although a few anticipated a 50 basis point cut, the vast majority of traders, investors and the futures market expected a 25 basis point cut. However, new information emerged from the meeting as the FOMC updates its dot plots quarterly, revealing the Fed voters’ projections for rates not only at the current meeting but also in future meetings over the coming years. Upon its release, the FOMC’s updated dot plots indicated an agreement with market expectations for two additional rate cuts this year, though this consensus was not unanimous. However, the FOMC diverged significantly from market expectations regarding 2026, with the median FOMC voter projecting only one further cut compared to the market’s pricing of three. Even for the remaining meetings this year, despite a general consensus, nearly half of the FOMC members suggested that only one rate cut would be necessary, as evidenced by the broad dispersion of dots in 2025. Is it possible that markets will not see more rate cuts in 2025?

When there is a difference in opinion between the dot plots and the market, it is not uncommon to see Fed speakers in the coming days and weeks clarify the Fed viewpoint and potentially convince the market that it needs to adjust pricing. In the week following the FOMC meeting, the hawks at the Federal Reserve strongly signaled to the market that inflation risks persist and warrent consideration. St. Louis Fed President Alberto Musalem supported the recent rate cut but sees limited room for further cuts due to elevated inflation. He sees current rates as being ‘between modestly restrictive and neutral.’ Another Fed member, Atlanta Fed President Raphael Bostic, told WSJ’s Nick Timiraos, known as a ‘Fed whisperer,’ that he saw little reason to cut rates further, and that inflation concerns would make him hesitant to declare further support for cutting rates. While Musalem is a known hawk, Bostic’s stance, though leaning hawkish, is not as consistently clear, making these headlines come as a surprise.

While there might be some disagreement among Fed presidents, there appears to be some disagreement in the market. According to FedWatch, there’s a 90% chance of another rate cut at the October 29 FOMC meeting. The dispersion of outcomes is narrow, with a 10% probability of no cut and the rest priced for one cut. If the Fed is truly data-dependent and on the fence about further cuts, is it possible that the market needs to move these odds for the upcoming FOMC meeting?

If the Fed is data dependent, it is worth looking at how the data is coming in relative to expectations. To analyze this, I examine the Bloomberg Economic Surprise Index. Comparing this index (white line) to the generic 2-Year Treasury futures (inverted, in blue) reveals a notable  co-movement over the past year. For instance, in March/April of this year, futures reached new highs, but the economic data had not decelerated. This divergence was resolved by futures retreating and pricing out rate cuts, aligning with the economic data. It wasn’t until the collapse of the Economic Surprise Index this summer that futures began the most recent run to new highs. Over the last two months, the Economic Surprise Index has steadily moved higher, indicating a stronger than-forecast economy. Will 2-Year Treasury futures begin to notice? If so, based on this simple overlay, there could be scope for a move to 103.50 or lower.

Turning to the charts, a few things stand out. The first is that generic front-month 2-Year Treasury futures have been relatively sideways in the past few months. It is at recent highs, though momentum may be beginning to wane. The middle panel displays the Moving Average Convergence/Divergence (MACD) line, which is crossing over and appears to be heading lower. In addition, while futures prices went back to the highs, the relative strength index did not, indicating a negative divergence that could also point to lower prices. While the Ichimoku Cloud shows good support around 103-20, the support from June lows is slightly lower, at 103-10. While it may not be huge, futures reverting to the summer lows may catch people off guard.

Who might be caught off guard? It is important to turn to the Commitment of Traders report to see how the various constituencies are currently positioned. The summary shows that dealers, others and non-reportables do not have meaningful positions at this time. However, it also shows that asset managers are very long the 2-Year futures, while leverage money is quite short. While leverage money was shorter at the end of 2024, the current short is the largest in 2025. The current long position among asset managers is the largest traders have seen in the last two years. Thus, it would seem if there were a catalyst, someone may need to change their mind between the bulls and the bears. Could continued strong data be the catalyst? Especially after the Fed indicates that cuts are not unanimous?

Is a catalyst, or a change of opinion, priced into the options market? It’s safe to say that there are no surprises built into the options market. Looking at the CVOL Index for 2-Year options, the current levels of volatility are at the lowest they’ve ever been this year. In addition, there is a somewhat positive correlation between futures prices and volatility, with low futures prices leading to lower volatility and vice versa. However, a significant disconnect has emerged: options suggest broad expections, while futures have reached new highs. Is it possible for these lines to meet in the middle, potentionally causing volatility to rise if futures fall? It might be possible due to the option markets suggesting that there will be no surprises to consensus, but a surprise to consensus would likely come from fewer cuts leading to falling futures prices. Regardless, it’s safe to say the hurdle rate of volatility is low, as it currently sits at a 12-month low.

Considering all these factors, a diagonal put spread could be a favorable strategy. Volatility levels are low, which means long volatility positions make sense. Directionally, surprises happen to the downside in futures markets, which means long puts make sense. Surprises likely stem from economic data, which has already exceeded market expectations, but a significant shift might not occur until the FOMC meeting on October 29, after the November options expire. Thus, the November options don’t capture the next FOMC, but December options do. When I look at the Event Volatility Calculator (not shown), there is no volatility priced into the October FOMC meeting. This suggests that buying options for December and selling for November is a way to be long volatility/vega but reduce the cost in the event there is little movement for the next month. By selling a slightly closer to at-the-money put in November (104.125 strike) and buying a slightly further out-of-the-money put (104 strike) in December, I am able to make this spread at almost zero cost. If you are willing to spend more premium, you can choose to do a calendar spread where the puts have the same strike.

The risks on a calendar spread is that futures move before you expect them to and the options you sell go in the money. If this occurs, you have a few choices: you can do nothing, assuming a trend is underway and your existing options will stop you out at the next expiration; you can close out the spread for a loss; or you can hedge the position delta neutral and long volatility for the upcoming expiration. With volatility at low levels, the last choice could be the more likely risk management option. If futures move higher before the FOMC meeting, traders will be left long the December 104 puts, which will be further out of the money. It may be too far out of the money to monetize anything, but this is why it may be preferable to spend a little premium on the spread. The best case scenario is for futures to stay where they are, or even drift a little lower, but not go below the 104.125 strike for November. Then traders are left long a December 104 put, which they paid a little premium for. With the FOMC meeting happening five days after the November expiration, traders will have time to either sell the puts in the market or decide to hold them for the FOMC meeting.

Diagonal spreads can seem difficult to risk manage, but if traders think through the scenarios ahead of time, it is possible to be disciplined in the risk management approach. The upside to the spread is potentially getting long ‘free’ options for a market-moving event. With implied volatility so low, it wouldn’t be a bad idea to just buy the December puts outright, but CME Group provides traders with the tools and the products to potentially optimize ‌trade implementation.

Good luck trading!

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