Powell’s recent comments show a change in the Federal Reserve’s focus from inflation risks that were stressed in July. He noted that weaker labor data, with payroll growth averaging just 35,000 over the last three months—down from 168,000 earlier in 2024—has influenced this shift. He also highlighted that tariffs still present inflation risks. However, Powell believes that current labor market conditions may limit workers’ ability to demand higher wages, which could help keep inflation from rising due to tariffs.

Predictions on Unemployment and Rate Cuts

Pantheon Macroeconomics predicts that employment challenges might push unemployment rates above the Federal Reserve’s forecast of 4.5% by the end of the year, potentially hitting 4.75% by late 2025. They expect inflation from tariffs to mostly affect goods and predict the Federal Reserve will cut rates by 25 basis points in September, November, and December, suggesting more cuts than the market currently expects. There is a noticeable shift in the Fed’s outlook, with Powell now prioritizing concerns about a weakening job market over inflation. The latest BLS report revealed a sharp slowdown in July payrolls, bringing the three-month average down to just 35,000, a significant decline from 168,000 in 2024. This may lead to easier monetary policy sooner than many think. While tariffs were a major worry earlier this year, their impact on inflation seems under control due to softer wage growth, giving the Fed room to act. With July’s annual CPI at a manageable 2.8%, the chance of inflation from tariffs becoming a long-term issue appears low. This view is backed by last month’s unemployment rate increasing to 4.3%, a trend we expect to continue.

Opportunities in Rate and Equity Markets

This situation creates a strong opportunity in interest rate markets, as we expect three rate cuts by year-end in September, November, and December. The markets are not fully aligned with this outlook; the CME FedWatch Tool shows only a 55% chance of a single 25-basis-point cut by December. Traders may want to consider strategies that benefit from falling rates, such as buying SOFR futures or call options on Treasury bond futures. This dovish stance is also a positive signal for stocks, reminiscent of the policy change in mid-2019 that led to a significant market rally. We anticipate this could lift stock indices, making long positions with S&P 500 call options an attractive strategy. With the Fed’s change in messaging, we may see increased volatility around the upcoming FOMC meetings, making VIX derivatives worth considering for short-term strategies. Create your live VT Markets account and start trading now.

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