Federal Reserve Governor Christopher Waller supports a 25 basis point rate cut at the upcoming July meeting, due to increased economic risks and signs of a weakening labour market. He suggests that waiting for more job losses before taking action may necessitate stronger measures later on.
Waller believes the inflationary impact of tariffs to be temporary, pointing out that core inflation remains near its target when trade pressures are excluded. With private sector hiring slowing and GDP growth around 1%, he expects limited risks of inflation rising.
Fed Rate Cut Strategy
Waller states that a rate cut in July could allow the Fed to pause in subsequent meetings, aligning policies more closely with a neutral stance as the economy decelerates. Both Waller and Bowman currently support the rate cut at the July 29-30 Federal Open Market Committee (FOMC) meeting, but with 12 voters on the committee, the support for a rate cut is not yet sufficient.
Based on the governor’s clear signal, we believe derivative traders should begin positioning for an increased probability of a July rate cut. His comments about acting pre-emptively to avoid a sharper downturn are a significant dovish shift. This suggests a change in the Fed’s reaction function, making them more sensitive to slowing economic data.
Recent statistics reinforce this perspective on the labour market. The latest report for June showed nonfarm payrolls increasing by a modest 209,000, while the unemployment rate ticked up to 4.1%, its highest level in over two years. These figures support his argument that private sector hiring is approaching “stall speed” and justify a proactive policy adjustment.
His view on inflation also finds backing in recent data, with the latest core Personal Consumption Expenditures (PCE) price index reading at 2.6% for May. While this is still above target, the six-month annualized trend has fallen closer to 2%, lending credibility to the idea that underlying price pressures are contained. This allows the central bank to focus more on its employment mandate.
Market Implications and Strategies
We have seen this policy playbook before, most notably in 2019 when the Fed executed a “mid-cycle adjustment” of three rate cuts. Those moves were made to insure against downside risks from trade tensions and slowing global growth, even without a recession, much like the rationale being presented now. This historical precedent suggests the market should take the possibility of a proactive cut very seriously.
For interest rate traders, this means we should consider going long futures contracts tied to the Secured Overnight Financing Rate (SOFR) for the third quarter. Market pricing, as seen in the CME FedWatch Tool, already implies a roughly 75% chance of a 25 basis point reduction, but these positions would profit further if conviction grows or the market begins pricing in a second cut.
Given the uncertainty over whether the full committee will agree, we see value in buying volatility ahead of the late July meeting. Purchasing straddles or strangles on the S&P 500 index could be profitable, as they benefit from a large market move regardless of whether it’s up on a dovish cut or down on a hawkish hold. The current divergence among voting members makes a significant price swing likely.
A more directional play would involve using equity derivatives to position for a positive market reaction to a cut. We could look at buying call options on the Nasdaq 100, as growth-oriented technology stocks are particularly sensitive to lower interest rates. This offers a leveraged bet that a more accommodative policy stance will fuel the next leg up in equities.
