Michelle Bowman, the vice chair of supervision at the Federal Reserve, has recommended three interest rate cuts by the end of 2025. This comes after a decline in the U.S. labor market, highlighted by significant downward revisions in the July nonfarm payrolls report. The report showed a notable decline in job growth, with May’s figures revised from 144,000 to 19,000 and June’s from 147,000 to 14,000. Bowman shared these observations at a bankers’ conference in Colorado Springs, stating that the weakening labor market poses a bigger concern than inflation risks.

Continued Economic Slowdown

Bowman expects to support three rate cuts in the remaining Federal Reserve meetings this year. She believes it’s necessary to shift towards a neutral policy stance because of the economic slowdown and declining labor market activity. Only three Federal Reserve meetings are left for this year, scheduled for September 16-17, October 28-29, and December 9-10. Bowman proposes a rate cut at each of these meetings. With significant changes upcoming from a top Federal Reserve official, market expectations for interest rates are shifting quickly. The large downward revisions to May and June job numbers indicate the labor market is weaker than we previously thought. For derivative traders, this means we need to adjust for a series of rate cuts starting as early as September. Recent inflation data supports this outlook, making rate cuts more probable. The latest Consumer Price Index (CPI) report showed that year-over-year inflation dropped to 2.8% in July, giving the Federal Reserve more reason to ease its policy. This marks a significant decrease from the higher inflation levels seen in much of 2024.

Financial Market Implications

In the bond market, we should expect yields to keep falling. The 2-year Treasury yield, sensitive to Fed policy, has already dropped below 3.5% this week following this news. Traders might consider buying futures on 10-year or 30-year Treasury bonds to profit from falling rates. For equity derivatives, this scenario is generally good for stocks, as lower borrowing costs can enhance corporate earnings. We recall how sharply markets rallied in late 2023 based on expected future rate cuts. Purchasing call options on major market indices, like the S&P 500, before the September meeting could be an effective way to capitalize on this anticipated rally. The U.S. dollar may also weaken as the Fed cuts rates while other central banks hold steady. The U.S. Dollar Index (DXY) recently fell below 101 for the first time this year due to this news. There are opportunities to use currency futures or options to bet against the dollar, particularly against currencies like the euro or the Japanese yen. While the prospect of rate cuts is soothing markets for the moment, the root cause is a quickly deteriorating labor market. The CBOE Volatility Index, or VIX, has dropped to 15, but this may not last if new data points to an impending recession. Buying some inexpensive, out-of-the-money VIX calls might serve as a useful hedge against a sharper economic downturn. Create your live VT Markets account and start trading now.

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