The Dow Jones Industrial Average rose by 482 points, or 1.04%, hitting a high before closing up 250 points, or 0.55%. Gains were limited due to declines in tech stocks like Palantir, Tesla, and Nvidia. This is the fourth week in a row that the Dow has performed positively or remained stable. Despite the U.S. government shutdown, the markets are staying optimistic, with expectations for a short closure.

Labor Market Impact

The lack of important labor data is making it harder for the Federal Reserve to decide on interest rates, increasing the chances of a rate cut on October 29. The Trump administration’s goal to reduce federal jobs during the shutdown may impact the job market. Overspending at the federal level has been noted every month since Trump took office, following an unsuccessful effort to cut costs. ADP Employment Change numbers showed the biggest drop in over two years, and the Nonfarm Payrolls report is postponed until the shutdown ends. The Institute for Supply Management (ISM) Services PMI reading was 50, below the expected 51.7. A reading above 50 indicates growth in the service sector, which can influence the strength of the U.S. dollar. The Employment Index and Prices Paid Index are crucial for analyzing labor and inflation trends. As the market reaches new highs, it faces economic challenges, creating a gap between sentiment and data. The CBOE Volatility Index (VIX) is currently at a calm level of 15, which seems low given the shutdown and softening labor signals. This indicates that buying VIX call options or options on volatility ETFs might be an inexpensive way to protect against a potential market drop in the coming weeks. We should closely watch the difference between the Dow’s strength and the recent weakness in tech stocks. Over the past month, the Dow has outperformed the Nasdaq 100 by nearly 4%, a trend that may continue if economic uncertainty lasts. Traders could consider strategies that take advantage of this difference, such as purchasing call spreads on the SPDR Dow Jones Industrial Average ETF (DIA) while buying put spreads on the Invesco QQQ Trust (QQQ).

Federal Reserve Rate Cut

The market is anticipating a Federal Reserve rate cut on October 29, with fed fund futures suggesting over an 85% chance of a quarter-point decrease. This expectation is supporting stocks, but it also poses a risk if the Fed does not meet these expectations or hints at a more aggressive approach. A contrarian strategy could involve using options on Fed Funds futures to bet against a rate cut, which would be profitable if the market’s expectations are wrong. The new ISM Services PMI reading of 50.0 is a major warning sign, indicating the weakest level of services activity since a brief slowdown during the regional banking issues in 2023. This decline, along with a poor ADP jobs report, shows that the economy may be weakening—a factor that the stock market seems to be ignoring. Thus, holding longer-dated protective puts on major indexes like the S&P 500 could be a wise strategy beyond the immediate concerns. Historically, extended government shutdowns, like the one in late 2018, often lead to temporary market dips before a resolution is reached. We could benefit from this by purchasing weekly put options on the SPY to profit from any increased anxiety as the shutdown continues. However, these should be viewed as short-term trades, as the market is likely to rebound sharply once a deal to reopen the government is reached. Create your live VT Markets account and start trading now.

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