Morgan Stanley notes that if payroll numbers are strong—around 225,000 for August—or if inflation rises sharply due to tariffs, this could postpone Federal Reserve (Fed) rate cuts this month. Some Fed officials are also discussing whether the central bank is acting too quickly, which could lead to disagreements.

Drop In Payrolls

On the other hand, a significant drop in payrolls might prompt the Fed to take action sooner, as markets might expect larger rate cuts. Morgan Stanley still believes that the Fed will adopt a more flexible approach over the next year. They foresee quarterly rate cuts until 2026, with rates eventually lowering to between 2.75% and 3.00%. A rate cut in September seems likely, but it’s not a certainty. Current estimates from CME FedWatch show about a 70% chance of a 25-basis point cut, which leaves room for surprises. This uncertainty presents opportunities in short-term options as traders prepare for the Fed’s decision later this month. The upcoming non-farm payrolls report for August is crucial before the meeting. If the report shows strong growth above 225,000, it could challenge the idea of a rate cut. Conversely, if the number comes in significantly below 150,000, the Fed may feel pressured to act. Past payroll data has caused major shifts in market forecasts, sometimes over 20%.

Rising Volatility

As a result, implied volatility is rising before the payrolls data release. The VIX index has climbed from a low of 14 to around 16, indicating that traders are buying protection or speculating on significant market moves. This setup is ideal for strategies like straddles or strangles on major indices, which profit from large price swings in any direction. We also need to keep an eye on inflation, especially with new tariff discussions. The latest Consumer Price Index (CPI) report for August showed core inflation stubbornly at 3.1%, slightly above expectations, partly due to rising import costs. Another surprise in inflation data might give more hawkish Fed members the argument they need to call for a pause in rate cuts. Looking ahead, the Fed’s policy appears to be leaning toward rate cuts. Expectations are for quarterly cuts to continue through 2026, indicating a steady decline in short-term interest rates. This long-term trend makes investing in interest rate futures or longer-term options appealing. For traders with a long-term perspective, call options on 2-Year Treasury Note futures (ZN) expiring in early 2026 could be beneficial, as they would directly benefit from the expected rate cuts. Alternatively, LEAPS call options on sectors sensitive to interest rates, such as technology and REITs, provide a way to tap into the broader economic trends. Create your live VT Markets account and start trading now.

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