Federal Reserve Chair Powell keeps options open for future rate cuts, though he hasn’t given any specific hints. After a disappointing US jobs report, there’s talk of a possible rate cut in September. Fed funds futures suggest there’s a 92% chance of a 25 basis point rate cut. By year’s end, about 60 basis points of cuts may happen in total. Fed officials seem to support this idea. Williams is open to acting in September, while Daly thinks two rate cuts might be necessary, though fewer cuts could also be a possibility. The Fed’s meetings in September, October, and December are likely to be very important.

Market Outlook on Rate Cuts

The market almost expects the Fed to cut rates in September. This follows some ups and downs in the stock market, with volatility rising after the jobs report. The market’s mood has shifted quickly from being optimistic about the economy to worrying about its health. People expect that rate cuts will help the economy, which fits a pattern of changing market views. With more agreement on a Federal Reserve rate cut, the market has almost fully priced in a rate change for September. The July jobs report showed a disappointing gain of just 95,000 jobs, compared to an expected 180,000, reinforcing this expectation. This makes the next six weeks look clearer. Fed funds futures now show over a 90% chance of a 25-basis-point cut at the September meeting. Although volatility, measured by the VIX, has lowered to around 17, the high confidence in the rates market presents a certain picture. The market is not expecting a surprise “no cut,” leading to a one-sided outlook. For traders in derivatives, buying call options on major indices like the S&P 500 during market dips could be wise. The prevailing view is that “bad news is good for stocks,” as it reinforces the argument for lowering rates. The expectation is that lower rates will support stock prices.

Historical Context of Rate Cuts

We’ve seen similar situations before, like the “insurance cuts” the Fed made in mid-2019. Back then, the Fed cut rates as a precaution, even without a recession, which helped boost the market. History shows that even the mere anticipation of such moves can positively influence risk assets. In interest rate markets, options on SOFR futures allow traders to take positions on rate cuts, but these options are costly due to high pricing. An alternative is to sell out-of-the-money puts on these futures. This strategy relies on the belief that the Fed won’t surprise the market with a more significant 50-basis-point cut. The main risk is that the Fed might resist the market’s expectations and choose to keep rates steady. This could lead to a sharp drop in equities. A small investment in inexpensive, out-of-the-money index puts could be a smart way to hedge against this unlikely, but possible, outcome. Create your live VT Markets account and start trading now.

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