The Federal Reserve is split on whether to keep interest rates the same or lower them. Only Waller and Bowman are in favor of a rate cut. There is disagreement about tariffs. Some officials want more clarity before making policy changes, while others think it’s better to wait for complete information. Most believe that inflation risks are more pressing than employment risks.

Dove Versus Hawk Debate

Doves, like Waller and Bowman, want to overlook price increases caused by tariffs and push for rate cuts. Hawks, on the other hand, worry about rising prices, particularly in services, and believe that the Fed’s current approach is effective at managing the impact of tariffs. Schmid from the Kansas City Federal Reserve criticized the way “inflation ex-tariffs” is calculated, calling it irrelevant. The minutes reveal a growing divide within the Fed, suggesting a heated discussion at the upcoming September meeting. Since July, the debate has heated up. Doves argue that tariff-induced price increases should be ignored and point to weak job data to support their call for early cuts. Meanwhile, Hawks notice rising price pressures and commend the Fed’s steady approach to handling tariff effects. Schmid furthered the division by rejecting the practice of excluding tariffs when calculating inflation. This increasing division in the Fed hints at potential market volatility in the weeks before the September meeting. The uncertainty between holding rates steady or cutting them means opportunities in options markets. The central question is whether to disregard tariff-related inflation, making the Fed’s next move tough to predict.

Market Implications

The July 2025 jobs report, released earlier this month, was weaker than expected, with only 150,000 new jobs added and the unemployment rate rising to 4.1%. This data supports the doves advocating for a rate cut in September to safeguard jobs. Conversely, the latest CPI reading shows core services inflation remains stubbornly high at 4.3%, giving Hawks a reason to maintain their position. This clear divide implies that the implied volatility on equity and rate derivatives is likely underestimated. The VIX index has risen from 14 to 19 in the past month, indicating growing policy uncertainty. Traders might consider buying straddles or strangles on major indices before the next inflation report and the September Fed decision, as these strategies benefit from large price swings in either direction. The interest rate futures market now estimates about a 40% chance of a 25-basis-point cut in September, a jump from only 15% a month ago. This suggests the dovish case is gaining ground, but it’s still uncertain. If the Fed decides to hold rates steady, short-term yields might surge sharply. Looking back at the policy debates of 2018, we saw that uncertainty around trade policies and Fed rate hikes led to notable market fluctuations. During that time, the Fed’s communication was crucial; any change in tone triggered sharp re-evaluations. We are likely entering a similar situation, where upcoming Fed speeches will be closely analyzed for any sign of direction. Create your live VT Markets account and start trading now.

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