Powell’s recent comments indicate a shift from the Federal Reserve’s July emphasis on inflation risks. He pointed to weaker labour data as an influencing factor, with payroll growth having averaged 35,000 over three months, a decrease from the previous 168,000 in 2024.
He mentioned that tariffs continue to pose inflation threats. However, he believes that the current labour market conditions could curb workers’ ability to demand higher wages, thus reducing the likelihood of sustained inflation from tariffs.
Predictions on Unemployment and Rate Cuts
Pantheon Macroeconomics predicts that employment issues might cause unemployment rates to exceed the Federal Reserve’s forecast of 4.5% by year-end, potentially reaching 4.75% by late 2025. It expects tariff-induced inflation to mainly impact goods and anticipates the Federal Reserve to reduce rates by 25 basis points in September, November, and December, suggesting more rate cuts than financial markets currently anticipate.
We are seeing a clear shift in the Fed’s thinking, with Powell now more concerned about a weakening labor market than inflation. The latest BLS report showed July payrolls slowing drastically, bringing the three-month average down to just 35,000, a significant drop from the 168,000 average seen through 2024. This opens the door for easier monetary policy sooner than many expect.
While tariffs were a concern earlier in the year, their inflationary impact seems contained as softening wage growth gives the Fed cover to act. With the latest annual CPI reading for July coming in at a manageable 2.8%, the risk of tariff-driven inflation becoming entrenched is now quite low. This view is supported by the unemployment rate ticking up to 4.3% last month, a trend we see continuing.
Opportunities in Rate and Equity Markets
This sets up a significant opportunity in interest rate markets, as we anticipate three rate cuts by year-end in September, November, and December. Markets are not fully aligned with this view, as CME FedWatch Tool data shows only a 55% chance of a single 25-basis-point cut by December. Traders should consider positions that will profit from falling rates, such as buying SOFR futures or call options on Treasury bond futures.
This dovish pivot is also a bullish signal for equities, reminiscent of the policy shift in mid-2019 that preceded a strong market rally. We expect this to boost stock indices, making long positions through S&P 500 call options an attractive strategy. Given the change in Fed messaging, an increase in volatility around the upcoming FOMC meetings could also make VIX derivatives worth considering for short-term plays.
