This year, the U.S. economy has displayed resilience amid changes in economic policy, maintaining near-maximum employment and reducing inflation from post-pandemic levels. However, new challenges are emerging, such as higher tariffs and tighter immigration policy, impacting growth and productivity.
The Federal Reserve’s approach to monetary policy is adapting accordingly. The current policy rate has remained between 5-1/4 to 5-1/2 percent to control inflation and balance demand and supply. Despite a slowdown in job growth, the labour market remains stable with an unemployment rate at 4.2 percent.
Economic Indicators
GDP growth declined to 1.2 percent in the first half of the year, largely from reduced consumer spending. Inflation has been influenced by tariffs, with PCE prices rising by 2.6 percent over 12 months to July, while core PCE prices climbed by 2.9 percent.
The revised monetary policy framework aims to address varying economic conditions while promoting maximum employment and stable prices. Changes include moving away from emphasising the ELB and adopting a flexible inflation targeting approach.
Inflation remains a key concern, addressed through the revised framework which ensures inflation expectations stay anchored. The Fed will continue to monitor economic conditions, adjusting its policy to support maximum employment and price stability. A public review of the framework will occur approximately every five years to adapt to economic changes and gather public insight.
The economic picture is becoming complicated, with risks to employment rising even as inflation pressures from tariffs persist. The Federal Reserve has signaled it is now balancing these opposing forces, a significant shift from its singular focus on inflation over the past few years. We must now position for a period of heightened uncertainty where policy could pivot based on the next major data release.
Positioning for Potential Changes
With job growth slowing to just 35,000 per month and GDP growth halving to 1.2%, the case for a more supportive monetary policy is growing. We should therefore consider positioning for potential interest rate cuts by looking at options on SOFR futures that would profit from a dovish turn in the coming months. The CME’s FedWatch Tool, which in August 2025 is showing a nearly 45% chance of a rate cut by the November FOMC meeting, reflects this building expectation.
However, the inflation side of the equation cannot be ignored, as tariffs are pushing core PCE prices up to 2.9%. This creates a stagflationary environment that could lead to significant market volatility. We believe purchasing protection through options is prudent, such as buying put options on the S&P 500 or call options on the VIX index, which has already risen from 14 to over 21 in 2025.
This situation has historical echoes, reminding us of the Fed’s pivot in 2019 when it cut rates due to slowing global growth and trade uncertainties, even though inflation wasn’t critically low. Given the downside risks to the labor market are now being explicitly highlighted, we expect the Fed may prioritize supporting employment. Therefore, strategies that benefit from a steepening yield curve, where short-term rates fall faster than long-term ones, should be evaluated.
A more dovish Federal Reserve would likely put downward pressure on the U.S. dollar relative to other currencies. As of August 2025, the European Central Bank and the Bank of Japan have not signaled a similar dovish tilt, creating a potential divergence in policy. We see opportunities in currency derivatives, such as buying call options on the euro or yen against the dollar.
Ultimately, policy is not on a preset course, making the next few weeks crucial for traders. The upcoming August Consumer Price Index and Employment Situation reports will be heavily scrutinized for any sign of weakening that could trigger a policy adjustment. Derivative positions should remain nimble, allowing for quick reactions to data that could either accelerate or delay a potential rate cut.
