The Fed is currently aiming to keep interest rates steady while tackling inflation. Although rates are close to neutral, inflation remains high, which calls for caution. The impact of tariffs on inflation appears limited, which supports the decision to avoid cutting rates.

Fed’s Internal Divide

Fed President Jeff Schmid, who tends to be hawkish, advocates for a careful approach before making any changes to the Fed’s policy rate. There is an acknowledgment that the full effect of tariffs on prices is unclear. If there are signs of reduced demand growth, opinions may change, but the current preference is to maintain policy unless absolutely necessary. Inside the Fed, opinions are divided about future rate changes. Bowman and Waller support cuts, while Musalem and Schmid prefer to keep rates steady. Barkin takes a neutral stance. Even though the market suggests a 90% chance of a cut, Fed Chair Powell’s upcoming speech at the Jackson Hole Economic Symposium could provide more insight into the Fed’s position. There’s a notable gap between market expectations and recent comments from the Federal Reserve. While the CME FedWatch Tool shows a 90% likelihood of a rate cut next month, voting member Jeff Schmid indicates a preference to hold rates steady. This difference between market predictions and the more cautious tone of a Fed official may lead to increased market volatility. Schmid’s cautious stance is supported by recent inflation data, which remains stubbornly above the 2% target. The latest Consumer Price Index (CPI) for July 2025 was 3.3%, indicating that price pressures haven’t eased enough to warrant an immediate shift in policy. This strengthens the case for maintaining current rates more than the market recognizes.

Market Reaction Strategies

This uncertainty suggests that options premiums on interest rate futures and major indices might be undervalued. Traders should consider strategies that capitalize on increased volatility, as significant market adjustments could occur following Chair Powell’s speech. The CBOE Volatility Index (VIX) is currently around 14, a level often seen before big market moves during uncertain policy periods. It’s important to recall how Jerome Powell has used the Jackson Hole symposium in the past to reshape market expectations. In August 2022, his brief and straightforward speech dashed hopes for a policy change, resulting in a sharp market decline. A similar hawkish stance on August 23rd this year could disrupt the market’s dovish outlook. If the hawkish viewpoint prevails and the Fed decides to hold rates steady, we could see a quick rise in short-term bond yields. Traders might think about buying puts on Treasury note futures or employing bearish spreads on equity indices like the S&P 500. The market’s strong expectation for a rate cut presents an unusual risk-reward scenario for those ready for a potential hawkish surprise. Create your live VT Markets account and start trading now.

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