Two, Five, or Eight Cuts?

Over the past couple of years, the number of rate cuts priced into the market have fluctuated meaningfully on economic data, geopolitical events, an election, and the many new policies that have followed it.

Through all the volatility, the implied y/e 2025 and 2026 SOFR landing spots have largely been the same. Said another way, the market anticipated a lot of easing over a relatively short period of time until earlier this year.

After Liberation Day in April, the rate at which cuts were expected decreased, spreading them over a longer period. Today, that sits at just over two 0.25% reductions during 2025 and three more in 2026.

The following graph outlines y/e 2025 and 2026 SOFR expectations over time.

It’s probably old news now, but the July jobs report resulted in a 0.25%+ slide in yields, meaning one more cut priced in before EOY.

What does that mean for you?

• 1-2 year cap costs down 25-35%+ across most structures
• 2-5 year swap rates around 3.35-3.45%
• More uncertainty!

Heading into last week, many market participants were calling for the first cut in September and another in December. Some even anticipated just one cut this year in December. What ultimately happens will be driven by the inflation and jobs data coming out between now and 9/17.

Regardless, the recent drop in rates is welcome news for anyone with an upcoming cap extension. Here’s a current table of generic costs in bps of notional.

*Priced assuming $100mm notional, 9/1/2025 start, Term SOFR, standard ratings

Here’s a thought:

• A 1 year 4.35% cap ensures your rate doesn’t get worse than it is today – tight protection with a small outlay upfront
• A 1 year 4.00% cap is projected to payout the first few months and 24% of the premium be recouped
• A 1 year 3.50% cap is projected to payout over half the term and 58% of the premium be recouped

All else equal, pushing the first cut to December results in payouts that cover 86% of the 4.00% cap premium and 110% of the 3.50% cap premium.

Bloomberg Intelligence recently shared an interesting note about the wide dispersion of trades on SOFR futures. For instance, the Y/E 2026 expectation is around 3.07%, or five cuts, but looking at options implied probabilities:

• The 80th percentile SOFR is 3.89% - two or less cuts
• The 20th percentile SOFR is 2.21% - eight or more cuts
  
  

Source: Bloomberg Finance, LP

The recent dip provides an opportunity to pick up tighter protection if you think the Fed will cut slower than expected.

But if you believe the Fed will cut in line with or quicker than expectation, spending as little as possible (or not hedging at all) could be more beneficial.

And if you’re in the 20th percentile camp, I might review where my loan floors are!