Bank of America is worried that inflation will stay above the target because of recent tariff increases. It recommends that the Federal Reserve not lower interest rates in September since the current economic data doesn’t justify such a move. In a note to clients, the bank emphasizes that some policymakers might be underestimating how a labor supply shock can affect inflation. Ongoing inflation and the effects of recent tariffs could remain a threat, with inflation still above the Fed’s 2% target.

Bank Warns Against Rate Cuts

Bank of America warns that cutting rates in September could start a trend of easing without solid proof that inflation is stabilizing. It believes there will be no rate cuts this year. The bank also notes that U.S. nonfarm payroll figures have been revised downward. This raises fears of “bad cuts,” which could happen if the labor market worsens instead of helping to control inflation. We believe that inflation is sticking around longer than many expect. The July 2025 Consumer Price Index was at 3.1%, still above the 2% goal. The new tariffs on imported electronics and industrial components create a fresh inflation shock. These developments challenge the idea that the Federal Reserve can afford to ease its policies. The Fed should refrain from lowering interest rates in September. The revision of June’s nonfarm payroll data—from 190,000 to only 150,000—raises the chances of making “bad cuts” based on labor market fears rather than having confidence in controlling inflation. We think those calling for rate cuts are underestimating how persistent inflation will be.

Market Implications and Strategies

For derivatives traders, this suggests that the market might incorrectly price how monetary policy will unfold. The CME FedWatch tool shows a 60% chance of a rate cut in September, which we believe is too optimistic. Traders should consider strategies that benefit from rates remaining high, such as selling September SOFR futures or buying payer swaptions. This uncertainty could lead to more market volatility. We observed similar spikes in the VIX in 2022 when the Fed needed to take more drastic actions than the market expected. Buying VIX call options or futures for September and October could be a smart hedge against a hawkish surprise from the Fed. If the Fed keeps rates steady in September, it may disappoint equity markets that are anticipating a shift to easing. A cautious approach is advisable, and traders should think about buying protective put options on the S&P 500 to safeguard portfolios against a possible market downturn from a revaluation of interest rates. Moreover, a hawkish Federal Reserve, especially while the European Central Bank is adopting a softer approach, suggests a stronger U.S. dollar. This makes long positions on the dollar appealing. Derivative opportunities related to a rising USD/EUR exchange rate could be attractive in the coming weeks. Create your live VT Markets account and start trading now.

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