BofA Securities believes the Federal Reserve will keep interest rates steady in 2025. This is despite some market chatter suggesting a possible rate cut as early as September due to weaker job data from July and significant revisions to previous months’ data. According to the CME’s FedWatch Tool, there is now more than a 90% chance of a rate cut at the Fed’s mid-September meeting. However, BofA analysts predict rates will stay between 4.25% and 4.5%. They only expect cuts if the job market truly worsens.

Market Confusion Over Economic Signals

Analysts warn that the markets might be misunderstanding the situation, mixing up recession fears with stagflation risks. Even though there are fewer jobs for workers, a decrease of 802,000 in the foreign-born workforce since April has kept the job market stable. BofA highlights that wage growth and total labor income remain strong. With inflation still above the Fed’s 2% target, cutting rates too soon could be a mistake without clear signs of economic trouble. Fed Chair Powell is likely to accept slower job growth as long as unemployment remains stable, focusing on controlling inflation rather than prioritizing employment. Currently, the derivative markets are pricing in over a 90% chance of a rate cut at the Fed’s September meeting. This reaction follows last Friday’s disappointing July jobs report, which showed only 110,000 new jobs instead of the expected 180,000. Significant downward revisions for May and June have added to this sentiment. Despite this, we believe the Federal Reserve will keep rates steady throughout 2025. The main issue is lingering inflation, with the latest Core PCE reading for June still at 3.1%, far above the 2% target. This situation resembles stagflation more than a simple recession, complicating the Fed’s decision-making.

Opportunities in Volatility

Traders should look beyond the headline job numbers and focus on the tight labor market. The recent decline in the foreign-born labor force has limited the supply of workers, helping to maintain a stable unemployment rate around 4.1% for much of the year. Average Hourly Earnings continue to grow at a 3.9% annual rate, indicating ongoing wage pressures. We have seen a similar disconnect in the past, especially in 2023, when markets expected rate cuts that never happened because the Fed prioritized fighting inflation over preventing a slowdown. The current situation feels like déjà vu, with the Fed likely willing to accept weaker growth to conquer inflation. This gap between market expectations and potential Fed actions presents a chance for traders to capitalize on volatility. Options tied to interest rate futures, like those related to the Secured Overnight Financing Rate (SOFR), may not fully reflect the risk of a hawkish move at the September 17th meeting. Traders should consider strategies that benefit from a rise in implied volatility leading up to that event. For those confident in the “no cut” outlook, calendar spreads in SOFR futures could be appealing. This involves selling near-term contracts (such as September or December 2025) that have priced in cuts too aggressively, while buying longer-term contracts. Such a strategy would profit if the Fed stays firm, leading to a rise in the front end of the yield curve. Create your live VT Markets account and start trading now.

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