US Federal Reserve Chair Jerome Powell spoke at the Jackson Hole symposium and hinted at a potential rate cut in September. He pointed out that labor demand and supply have both slowed, even though inflation from tariffs is causing temporary pressure. Powell also expressed concerns about the labor market, emphasizing that the Fed will rely on data to make decisions in response to outside pressures. Following his remarks, markets reacted strongly, pricing in a 90% chance of a rate cut in September. Fed official Hammack expressed a different view, focusing on controlling inflation. She highlighted ongoing inflation issues and emphasized that policies should remain mostly restrictive. While she acknowledged the need to consider new data, she insisted that major weakness in unemployment is necessary before changing policy, due to worries about inflation continuing.

Market Performance

US stocks rallied, with the NASDAQ moving above important moving averages and closing higher, although weekly results were mixed. The NASDAQ dropped 0.58%, while the Dow gained 1.53% and the S&P rose by 0.27%. The small-cap Russell 2000 surged 3.86% today, finishing a week up 3.298%. European markets also closed higher, with all major indices making gains, and Southern Europe reaching new highs. US yields fell, particularly in the short term, as traders expected Fed cuts. This led to a significant drop in the US dollar against other major currencies. The Fed is signaling a potential rate cut in September, and markets are adjusting rapidly. We recommend positioning for further increases in stocks, especially in rate-sensitive areas like the NASDAQ and Russell 2000. Buying call options or setting up bullish spreads could take advantage of this strong momentum. This dovish shift follows recent economic reports, including early August 2025 jobs data, which showed a rise in unemployment to 3.9% despite solid overall numbers. This gives the Fed reason to focus more on employment. In the coming weeks, it seems likely that stock prices will rise while front-end bond yields will fall.

Market Strategy

The bond market’s reaction, with a nearly 10 basis point drop in the 2-year yield, indicates that traders are betting on lower policy rates. We can take advantage of this by investing in short-term interest rate futures or options that will gain from falling yields ahead of the September meeting. We observed a similar trend in late 2023, when the markets anticipated the Fed’s eventual shift, resulting in a strong rally in fixed income. However, with a 90% chance of a cut already factored in, the market is susceptible to strong data that might challenge this expectation. The July 2025 CPI report showed core inflation at a stubborn 3.2%, which more hawkish members like Hammack will take seriously. To manage the risk of a hawkish surprise in the next inflation report, it’s wise to hedge long equity positions by purchasing inexpensive, out-of-the-money put options. The US dollar has sharply declined against all major currencies, and we expect this trend to continue as rate differences close. We should look to short the dollar against currencies from stronger economies, like the Euro, especially as European indices hit multi-year highs. The Australian dollar’s 1.07% rise also indicates strength in commodity-linked currencies as global growth fears diminish. The remarkable 3.86% rally in the Russell 2000 signals a significant return to risk assets. Small-cap companies are highly affected by interest rates, so we should explore trades that could benefit from their continued outperformance. Using options on the IWM ETF could give us leveraged exposure to this trend as the market anticipates a more favorable credit environment. Create your live VT Markets account and start trading now.

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