UBS anticipates the Federal Reserve will cut rates by 75 basis points by early 2026. The Federal Reserve is focusing on labour market weakness over inflation spikes.
Jerome Powell noted labour demand has reduced, with job creation below levels needed to maintain current unemployment rates. Nonfarm payrolls averaged 27,000 per month since May, with a reduction of 911,000 in total payrolls.
Inflation and Tariff Impacts
Despite the labour market issues, the Fed continues to juggle concerns about inflation levels. Core inflation was stable at 3.1% year-on-year in August. Tariff-related price increases are seen as temporary, with the Fed projecting inflation to approach target by 2027.
The rate cuts could impact markets by weakening the dollar if other currencies remain stable. There may be downward pressure on front-end yields while inflation expectations limit long-term increases. Easier monetary policy could support risk assets, though labour market weakness might dampen this. US equity indices have hit record highs recently. In commodities, limited Fed tightening risk is expected due to tariff-driven inflation being temporary.
We see the Federal Reserve signaling that it is more concerned about the weakening labor market than a temporary rise in inflation, suggesting more rate cuts are on the way. With nonfarm payrolls averaging just 27,000 since May 2025 and initial jobless claims at a multi-year high, traders should anticipate lower short-term interest rates. This environment makes buying SOFR or Fed Funds futures an attractive strategy to position for the expected easing.
Currency and Equity Implications
Downward pressure on the dollar is a likely outcome, especially if other central banks hold their rates steady. As we saw the U.S. Dollar Index (DXY) dip below 102 this week, a clear divergence is forming with the European Central Bank, which just maintained its policy rate. Traders could consider buying call options on the EUR/USD or AUD/USD to capitalize on this growing policy gap.
For equities, this easing bias provides a supportive backdrop, even as the weakening job market presents a headwind. The S&P 500 hit a new record high yesterday, but with the CBOE Volatility Index (VIX) creeping up to 16, there is underlying uncertainty. Selling out-of-the-money put spreads on major indices could be a way to benefit from the belief the Fed will prevent a major market decline.
The view that tariff-driven inflation is a one-off event reduces a major risk for commodities. A weaker dollar and lower real yields are historically bullish for assets like gold, which has already responded by climbing to $2,380 an ounce. This creates a favorable environment for long positions in precious metals and other dollar-denominated commodities.
