Federal Reserve chair Powell maintained flexibility regarding future rate cuts, though no hints were given. Following a poor US jobs report, there is speculation on a potential rate cut in September. Fed funds futures show approximately 92% odds of a 25 basis point rate cut. By the end of the year, around 60 basis points in total rate cuts are anticipated.
Fed officials indicate support for this expectation. Williams expressed openness to a move in September, while Daly suggested that two rate cuts might be the appropriate adjustment. Daly mentioned the potential for fewer cuts, though two or more is likely. The Fed’s upcoming meetings in September, October, and December are expected to be pivotal.
Market Outlook on Rate Cuts
Market expectations suggest an almost inevitable decision for the Fed to proceed with a rate cut in September. This comes amidst recent fluctuations in the equity market, with volatility following the US jobs report. The market has rapidly shifted its outlook, moving from optimism about economic strength to concerns over economic weakness. There is an expectation that impending rate cuts will support the economy, reflecting a long-standing trend of evolving market narratives.
Based on the growing consensus for a Federal Reserve rate cut, we’re seeing the market fully price in a September move. The July jobs report from last week, which showed a disappointing gain of only 95,000 jobs against an expected 180,000, has all but sealed this expectation. This makes the path for the next six weeks seem clearer.
Fed funds futures now reflect this certainty, indicating over a 90% probability of a 25-basis-point cut at the September meeting. While volatility, as measured by the VIX, has calmed to around 17, this high degree of certainty in the rates market presents a specific landscape. The market is not pricing in a surprise “no cut” scenario, creating a one-sided expectation.
For derivative traders, this suggests that buying call options on major equity indices like the S&P 500 during any market dips could be a sound strategy. The narrative is firmly in the “bad economic news is good for stocks” camp, as it reinforces the case for monetary easing. The expectation is that lower rates will act as a safety net for stock prices.
Historical Context of Rate Cuts
We have seen this play out before, particularly when we look back at the “insurance cuts” the Fed delivered in mid-2019. At that time, the central bank cut rates as a preventative measure even without a recession, which helped propel the market higher. History shows that even the anticipation of such moves can be a powerful tailwind for risk assets.
In the interest rate markets, options on SOFR futures are a direct way to position for the cut, but with it being so heavily priced in, call options are expensive. An alternative could be selling out-of-the-money puts on these futures. This strategy collects premium based on the belief that the Fed will not surprise markets with a larger 50-basis-point cut.
The primary risk is the small chance that the Fed pushes back against the market and chooses to hold rates steady. This would likely trigger a sharp, negative reaction in equities. A small allocation to cheap, out-of-the-money index puts could serve as a prudent hedge against this less likely, but still possible, outcome.
