**Economic Growth Slowdown** Monetary policy is still tight, but it’s more neutral than it was last year. There are rising risks for inflation and falling risks for employment, which requires a careful approach. The Federal Reserve updated its framework in 2025, removing some phrases about the zero lower bound and adopting flexible inflation targeting. The Federal Reserve is committed to being adaptable. This ensures that long-term inflation expectations stay stable and that they can balance goals for inflation and employment. Their aim is to reach maximum employment and a 2% inflation target, maintaining transparency and accountability. **Market Volatility Ahead** The Federal Reserve is struggling with slowing growth and ongoing inflation, leading to uncertainty. This cautious, data-driven approach signals that we might experience higher market volatility in the near future. We recommend preparing for this by using options, like buying VIX call spreads or straddles on the S&P 500 ahead of the September jobs report. The VIX has already risen close to 19, highlighting the potential for market swings. The new policy guidelines put aside hopes for quick rate cuts. With core PCE inflation at 2.9% and new tariffs in play, the chance of easing policy is now much lower. We anticipate that the yield curve will continue to flatten. The 2s10s Treasury spread, which recently fell to -15 basis points, is likely to invert even more. The impact of tariffs might be underestimated, as they could cause persistent price increases rather than just a one-time jump. Although the Fed insists it won’t let this lead to continuous inflation, we are seeing upward pressure on market-based inflation expectations. For instance, 5-year breakeven rates have increased by 10 basis points to 2.4% since the tariff news broke, indicating that derivatives to hedge against higher-than-expected inflation are becoming more valuable. With payroll growth dropping to only 35,000 jobs per month and GDP growth for the first half of 2025 slowing to 1.2%, concerns about the economy’s downside risks are now more significant. This situation is challenging for sectors that depend on strong economic growth. Therefore, we are using options to gain downside exposure to industrial and consumer discretionary indices, which underperformed during the last earnings season. The Fed’s updated framework, which has removed the dovish view on “shortfalls” in employment, allows them to keep policies tight even if unemployment rises to 4.2%. They’ve made it clear that they may take preemptive action if wage growth jeopardizes their inflation target. This strengthens our belief that the central bank is willing to endure more economic pain than it would have under its previous guidance from 2020. Create your live VT Markets account and start trading now.

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