June 26 (Reuters) - Investors began bracing for higher interest rates from the Federal Reserve after the start of the Iran war and shifted that process into a higher gear following Kevin Warsh’s first meeting as chair of the U.S. central bank last week.
However, derivatives contracts tracking market views of Fed policy indicate that the high-rates fear may have climaxed and expectations could even start adjusting lower.
SOFR futures are derivatives contracts used to bet on the direction of U.S. interest rates. Their price, which is expressed in an index format, moves in the opposite direction of rates.
When the SOFR contract expiring in March 2027 fell to a 1-1/2 year low on Monday, it reflected elevated expectations that the Fed would deliver two interest rate increases of a quarter point over that time horizon.
March 2027 SOFR had been in a pronounced downtrend since the start of the Iran war, but stopping at that low — 95.79, according to data supplied by LSEG — turns out to be a significant sign of a potential transition in market sentiment.
That level is known in technical analysis as “structural” support, which is a point where market prices often halt on the way down. In fact, the market has halted on several occasions in the area around 95.79 for nearly three years, so the bounce higher after its latest visit is worth noting.
Market follow-through in this move higher in the SOFR price — indicating lower rate expectations — came after a benign interpretation among investors of inflation data released on Thursday. That view, also characterized by lower bond yields, suggests that investors have received backing from economic fundamentals for a further easing of interest rate expectations.
If that turns out to be the case, and SOFR prices extend their gains, the next potential targets would be the 96.10-15 area, which would remove more than one rate increase from market expectations compared to the recent low. Further gains would target 96.30-35 and then possibly the 96.50 area.
However, a sustainable drop back below 95.79 would be a sign that rate fear had returned to the market with a vengeance.
What the chart shows:
SOFR was falling since the Iran war started
SOFR slide stops at key 95.79 level
First target on continued rise would be the 96.10/15 area
(Daily markets commentary from Reuters analysts on the signals financial charts are sending - and what they might mean.)
Christopher Romano is a Reuters market analyst. The views expressed are his own; Editing by Burton Frierson and Nia Williams
