The Dow Jones Industrial Average bounced back on Friday, lessening losses from earlier in the week. This comeback happened as predictions of an interest rate cut in October looked more promising. The US Personal Consumption Expenditures Price Index (PCE) inflation aligned with market expectations, giving hope for a possible rate cut.

Core Inflation Holds Steady

Core PCE inflation stayed at 2.9% yearly, which matched predictions. The monthly rate remained at 0.2%. Meanwhile, headline PCE inflation rose to 0.3% monthly and 2.7% yearly. We are now eight months into the inflation impact from tariffs, and core annual PCE metrics are at levels not seen since March 2024. Despite limited progress on inflation, the markets are optimistic. PCE data did not suggest the Federal Reserve is ready to adopt a more aggressive approach. With a weakening job market, the Fed expects to cut interest rates by another quarter-point on October 25th, with almost 90% of predictions supporting this move. In August, Personal Income increased by 0.4% and Personal Spending by 0.6%. Rising income is a positive sign for the economy but may pose future inflation challenges for the Fed. Consumer Expectations and Sentiment Indexes for September dropped slightly, indicating changes in market outlook. The PCE data from the US Bureau of Economic Analysis reflects changes in consumer spending, serving as the Federal Reserve’s preferred way to measure inflation. It includes monthly updates on Personal Spending and Income, which can influence economic policy and expectations.

Market Expectations and Fed Decisions

The market is largely anticipating a Federal Reserve rate cut on October 25th, with futures indicating nearly a 90% chance of a 25-basis-point reduction. This follows the initial cut from the Fed’s September 17th meeting, marking the first reduction since the aggressive rate hikes of 2022-2023. Such strong expectations mean that any unexpected news could lead to significant market fluctuations. The expectation of a rate cut is driven by a softening job market. The latest jobs report for August showed an increase of only 95,000 non-farm payrolls, significantly lower than the expected 150,000. The unemployment rate has also risen to 4.2%. The Fed seems to value this labor market slowdown more than ongoing inflation rates. However, core PCE inflation remains fixed at 2.9%, a level that has been hard to surpass since early 2024. This stubbornness, along with strong personal spending, poses a risk that the market may be overlooking. Traders should be wary; any higher-than-expected inflation data in the coming weeks could swiftly shift the Fed’s stance. With the VIX volatility index low at around 13, options are relatively affordable, presenting a clear opportunity. Traders should think about buying protective puts on major indices, like the S&P 500 or Nasdaq 100. This serves as a budget-friendly hedge against the possibility of a hawkish pause from the Fed due to persistent inflation. For those who align with the market’s dovish outlook, call options on rate-sensitive sectors like technology and real estate might be appealing. If a rate cut is confirmed in October, it could spark further gains in growth stocks, continuing Friday’s momentum. High rates held in 2024 have created a backlog of demand for these assets. A more detailed strategy could involve trading on volatility itself, as current market calm may not last. Traders could use calendar spreads on an index ETF like SPY by selling a short-term option to take advantage of the low immediate volatility and buying a longer-term option. This positions them for a potential increase in volatility around or following the Fed’s decision in October, regardless of the outcome. Create your live VT Markets account and start trading now.

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