Is AI changing interest rate expectations? Traders are betting that the Federal Reserve will still cut rates next year rather than raise them!

Latest signs indicate that traders in the US futures and options markets are betting that the Federal Reserve will continue to cut interest rates next year rather than raise them.

As shown in the chart below, the futures spread linked to the Secured Overnight Financing Rate (SOFR) is currently deeply inverted — a spread that closely reflects Fed policy expectations. This marks the beginning of traders pricing in a longer-term easing cycle by the central bank.

Previously, traders widely expected the Fed to cut rates twice by 25 basis points this year and then resume rate hikes in 2027. But recent debates over AI’s impact on the labor market may be prompting them to reassess this outlook.

Federal Reserve Board Governor Cook warned on Tuesday that the central bank might be unable to respond to rising unemployment caused by the proliferation of artificial intelligence.

Since last weekend, the flattening trend of the SOFR spread has accelerated notably, coinciding with growing industry concerns about AI’s disruptive potential, which has affected many stocks and driven long-term government bond prices higher.

“The key is how AI might trigger inflation, and the long-term yield curve may have already sensed these signals,” said Jack McIntyre, portfolio manager at Brandywine Global Investment Management. “The only way AI could potentially cause inflation is through data center construction and related energy demand, which is already a given.”

Data shows that the 12-month SOFR spread between December 2026 and December 2027 turned negative last Friday, and by Tuesday, the inversion widened to -8 basis points, indicating investors are shifting from pricing in rate hikes in 2027 to pricing in rate cuts. During Monday’s trading session, the volume of these 12-month spread trades exceeded 150,000 contracts, hitting a record high.

In the SOFR options market, similar dovish themes are also emerging through hedging trades betting on multiple rate cuts this year.

These trades became active again on Tuesday, with one position betting that the policy rate could fall to 2% by year-end expanding in size. The open interest in call options with a strike price of 98.00 expiring in December surged rapidly, reaching over 400,000 contracts. In comparison, the current interest rate swap market prices the Fed’s year-end rate at about 3.1% — roughly two 25-basis-point cuts — about 110 basis points above the implied level from these options.

Gennadiy Goldberg, head of US interest rate strategy at TD Securities, noted that after the Fed hits its terminal rate, the market has indeed repriced for lower yields, currently “preparing for yields to rise more gradually.” He added, “This may be driven by uncertainty about AI’s impact on the labor market, but long-term Fed rate expectations tend to be very volatile, making these expectations more difficult to interpret.”