Federal Reserve Vice President Phillip Jefferson noted that both employment and inflation are currently challenges for the Fed. The job market shows new signs of weakness, with increasing inflation concerns. One significant factor is the drop in net immigration, which has helped keep unemployment from rising sharply. However, if the job market continues to soften, it could face more pressure.

Policy Changes

Recent policy changes aim to create a more neutral approach while maintaining balance. Tariffs are driving up prices in some goods, but a decrease in inflation is expected next year. The Fed decided to remove “average” from its framework because it complicated communication. The strategy of allowing inflation to run above the target to make up for previous overshoots has not worked well. The Fed is also exploring how artificial intelligence could impact productivity. They are confident that they will still reach their 2% inflation target, with long-term inflation expectations steady at this level. Although tariff changes have shown a modest effect, the inflation impact may be slower than anticipated. The Fed’s job includes making sure these tariff changes don’t result in lasting inflation. The Federal Reserve is in a tough spot, facing both a weaker job market and ongoing inflation. The September 2025 jobs report highlighted this trend, showing a gain of only 110,000 jobs while the unemployment rate rose to 4.2%. Meanwhile, Core CPI data from August remained stubborn at 3.1%, leaving the Fed’s next steps uncertain.

Market Strategies

This environment is suitable for long volatility strategies, as the Fed’s careful balancing could lead to sudden market shifts soon. Acquiring straddles or strangles on major indices ahead of the late October Fed meeting may be wise for those looking to prepare for surprises in either direction. The VIX, currently around 19, seems not to fully reflect the risk of either a strong inflation-focused statement or a substantial dovish shift if job data worsens. In the interest rates market, there’s an opportunity for trading. The Fed funds futures market is pricing in a 60% chance of another 25-basis-point rate cut by December, yet Fed officials keep saying their work on inflation isn’t finished. This situation suggests that paying fixed on short-term interest rate swaps or using options on SOFR futures could be worthwhile if the Fed must keep rates higher for longer than the market anticipates. This uncertainty in policy is putting downward pressure on the US dollar, as future interest rate paths are less clear than earlier in the year. We saw a similar situation in late 2023, when the market started predicting rate cuts before the Fed was ready to indicate a shift. Therefore, call options on gold and other currencies against the dollar appear more appealing as a hedge against potential policy mistakes and persistent inflation. Create your live VT Markets account and start trading now.

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