The US dollar finished the day mostly stronger, gaining against the New Zealand dollar (+0.30%) and the Japanese yen (+0.26%). Most major currencies changed slightly, moving within 0.11% of their previous levels. The University of Michigan consumer sentiment dropped below expectations to 55.4, which later weakened the dollar. Even with this drop in sentiment, US bond yields increased, with the 2-year yield rising 3.3 basis points to 3.561% and the 10-year yield at 4.066%. Treasury auctions showed strong international interest in 3- and 10-year securities. The stock market had mixed results: the NASDAQ hit a record high, while the Dow and S&P indexes fell.

Central Banks Rate Decisions

Next week, four central banks will announce their interest rate decisions. The Federal Reserve may lower rates due to falling consumer sentiment. The Bank of Canada might also cut rates as economic growth slows. The Bank of England is expected to keep rates steady despite high inflation. The Bank of Japan may hold its rates unchanged, with a possible hike later this year. These decisions will likely impact global markets next week, focusing on inflation, labor data, and geopolitical factors. With the Federal Reserve meeting next week, we anticipate the start of a rate-cutting cycle. Current markets indicate a 92% chance of a 25-basis-point cut, the first since the rate hikes began in 2022. Traders are using options to bet on future cut speeds, expecting this to be the first of several cuts by year’s end. With central bank decisions coming from the US, Canada, UK, and Japan in a short period, market volatility is expected to rise. The CBOE Volatility Index (VIX), known as the “fear gauge,” has been edging up from its summer lows, closing yesterday at 14.8. We are purchasing VIX call options or straddles on major indices to take advantage of significant price swings, no matter the direction.

Divergence in Monetary Policy

The differences in monetary policy create clear opportunities in currency markets, especially with the Japanese yen. While we expect the Fed to cut rates, the Bank of Japan may hike later this year to address its inflation and weak currency. This sets up a favorable trade to go long the yen against the dollar, which we can do by buying call options on the FXY ETF or shorting USD/JPY futures. In equity markets, there’s a divide between soaring tech stocks and a weaker broader market. The NASDAQ achieving a new record while the Russell 2000 small-cap index declines highlights a trend toward quality and growth. Traders prefer call options on large-cap tech stocks benefiting from lower rates while using put options on the IWM ETF as a hedge against slowing economic data impacting smaller companies. The bond market shows concern, as the yield curve continues to flatten, with short-term rates increasing more than long-term ones this past week. We recall how the Fed reacted to a University of Michigan inflation report in 2022. With 5-year inflation expectations climbing again to 3.9%, traders believe long-term inflation will remain persistent. This supports trades that profit from the narrowing spread between 2-year and 10-year Treasury yields. This cautious stance is backed by recent economic data indicating a slowing economy but not a collapse. The latest Non-Farm Payrolls report for August 2025 showed only 95,000 new jobs, putting more pressure on the Fed. However, core inflation remained at a stubborn 3.8%, explaining why the central bank might deliver a “hawkish cut” with careful language next week. Create your live VT Markets account and start trading now.

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