The latest US jobs report was softer than expected but did not raise worries about a recession. This has led to optimism in the market, anticipating that the Federal Reserve will lower rates more than previously thought, with cuts expected to total 134 basis points, bringing rates close to 3%. As a result, the S&P 500 added 22 points, up 0.35%, hitting a new high of 6525. The Russell 2000 also saw a bigger jump, increasing by 1.3%.

Market Optimism

The market is lively after the August jobs report showed a moderate payroll increase of 150,000, easing fears of an overheated economy. This number isn’t low enough to suggest a recession, allowing the S&P 500 to reach new highs around 6525. The main factor is that investors now expect the Fed will cut rates aggressively over the next year. A key concern is that with 134 basis points in cuts already anticipated, there may be little room for more positive news to drive prices higher. The VIX volatility index is around 13.5, near yearly lows, making option premiums cheaper. This presents an affordable way to buy protective puts on major indices like the SPX to guard against any negative economic data. Meanwhile, small-cap stocks in the Russell 2000 are doing well. These companies are more affected by borrowing costs and the domestic economy. Traders might look at call spreads on the IWM ETF to engage in this ongoing rally while keeping their risk manageable. A similar situation occurred in late 2019 when the Fed began cutting rates, benefiting smaller domestic firms first. However, there’s a risk in the market’s excitement over a slowing economy, which often leads to trouble. We recall the period from 2000 to 2001 when the Fed cut rates, but stock prices fell as corporate earnings declined. If upcoming inflation data comes in higher than expected, it could quickly reverse these rate cut predictions and impact the current market enthusiasm.

Risk Mitigation

In the coming weeks, it would be wise to choose strategies with a clear risk profile, like credit spreads or iron condors. These strategies can benefit from time decay if the market remains steady around its new highs, especially since so much good news is already priced in. The next big trigger will be the upcoming Consumer Price Index (CPI) report; if it shows a high number, it could undermine the entire rate cut narrative. Create your live VT Markets account and start trading now.

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